With interest rates so low, are annuities effectively dead?

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Lbill
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With interest rates so low, are annuities effectively dead?

Post by Lbill » Mon Dec 27, 2010 8:41 pm

A part of my retirement investing strategy was to purchase one or more single premium fixed income annuities at about this point in time. However, interest rates have collapsed for annuities. Some commentaries I've been reading lately suggest buying an annuity comes close to committing financial suicide, because you would be locking in next-to-nothing interest rates for eternity. I'm wondering what others are thinking, and if anyone thinks purchasing a life annuity still makes any sense and why?
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Post by Call_Me_Op » Mon Dec 27, 2010 8:48 pm

Isn't this early for you to do that? My understanding is that annuities really only make sense at ~ age 80, as longevity insurance.
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Post by SP-diceman » Mon Dec 27, 2010 8:54 pm

Ahhh, good old deflation.

I wouldnt trust an annuity.
Either you get nothing or they take high risk.
(whoops, we thought we could get you 8% for 20 years)

Of course you could buy Greek bonds.



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SP-diceman

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real annuities and real yields

Post by bobcat2 » Mon Dec 27, 2010 9:04 pm

I would expect 30 year TIPS on average to have real yields in the 2.3% - 2.5% range. Currently 30 year TIPS are yielding about 1.9%. So if you buy an inflation-indexed life annuity now while you are in your mid 60s, you will be buying when LT real yields are below average, but not dramatically below average. Both nominal and real yield curves are fairly steep right now.

So if you were counting on purchasing real life annuities over time, I would recommend that you simply buy a little less now than you had previously planned.

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Post by #Cruncher » Mon Dec 27, 2010 9:23 pm

bobcat2's advice seems sound to me.

If you want some more information about annuities and how they fit into a retirement plan, I suggest Jim Otar's Unveiling the Retirement Myth. Chapters 33-36 discuss the various types. And chapters 41-44 discuss their roll depending on how well (or poorly) your retirement is funded: what he calls the Green, Gray, and Red zones.

For a limited time you can download a PDF copy for free: http://www.retirementoptimizer.com/

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Post by Ron » Mon Dec 27, 2010 9:37 pm

For me, an SPIA's key word is "Immediate"; that is an insurance vehicle (certainly not an investment, IMHO) to provide one funds in a specific situation. That situation is different for every person that may consider one.

Sure, you could wait till age 80. And maybe interest rates will go up (or not). It's no difference of delaying SS from age 62 till age 70, and getting a much higher benefit.

That increase is mostly due not by interest rates, but rather the length of time that you will collect. Like SS, an SPIA can pay at a perceived higher rate, since the payout would be for a lesser period of time. It’s no different than somebody using the 4 percent withdrawal guidance, but if you have the funds and you are in your 80’s (or above), you may consider a higher withdrawal rate.

For me (and my wife), an SPIA purchased at the time of my retirement at age 59 worked out well. Although interest rates were only slightly higher than today (mid-2007) it provides a good, constant income stream. I don't have a pension. I did not take SS at age 62 (I'm waiting till age 70).

Additionally, the funds to purchase the SPIA were taken out of our retirement portfolio, which reduced those dollars to the flux of the 2008 period. That's just luck, but it is something to be considered. You not only lose the possibility to gain more by leaving those funds in the market but also may limit your loss if the market goes down for an extended period of time.

As far as the value to us, it acts as a pension early on in retirement. Since we maximized the monthly payment, we are risking value loss over the long term due to inflation. But the counter-point is it is allowing us to delay our respective SS benefits, and "trading up" to a benefit that is inflation adjusted and will be higher since the SPIA allows us to delay SS.

Are SPIA's a "magic bullet"? Of course not. However, depending on your specific need and specific retirement income plans, they could assist you in your long term needs.

I also agree that if you do purchase an SPIA, you should do it in steps. Buy what you need to support your immediate plans, but buy additional policies as the need arises. You don't have to throw all your chips in at the beginning of the retirement game.

One final comment concerning the "you get nothing" comment. Our SPIA is a lifetime contract for both of us (if one passes, the payments continue at 100%). Also, it has a minimum term. If both pass before the term ends, the remaining payments go to our estate. However, if we (one/both) live beyond the term, payments continue at 100% till we are both gone.

Just my $.02.

- Ron

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Post by dmcmahon » Mon Dec 27, 2010 9:44 pm

It sure seems like buying a fixed annuity (one without a COLA) will lock in today's ultra-low rates, which doesn't seem like a good idea to me. Bobcat alludes to COLA'ed annuities, which won't quite lock in today's low rate structure but may be locking in below-market real yields. (Then again, past yields on US TIPS may never return, we may be headed towards the low real yields seen in inflation-protected securities in other countries.) One big caution, check the COLA provisions carefully, as many plans probably have a cap on the maximum inflation adjustment. If we repeat the 1970s, this could result in unexpected loss of purchasing power.

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Re: With interest rates so low, are annuities effectively de

Post by Taylor Larimore » Mon Dec 27, 2010 10:26 pm

Lbill wrote:A part of my retirement investing strategy was to purchase one or more single premium fixed income annuities at about this point in time. However, interest rates have collapsed for annuities. Some commentaries I've been reading lately suggest buying an annuity comes close to committing financial suicide, because you would be locking in next-to-nothing interest rates for eternity. I'm wondering what others are thinking, and if anyone thinks purchasing a life annuity still makes any sense and why?
Hi LBill:

In my opinion, it is usually worthwhile to wait until about age 80 to purchase a single premium immediate life annuity (SPIA). This type annuity, offers several advantages:

1. It provides the largest guaranteed lifetime income of any security (purchased at any age).

2. Purchased at age 80, a life income annuity will currently guarantee approximately $12,000/year (not inflation adjusted)--as long as you live.

3. A life annuity provides insurance you will not outlive your money.

4. Annuities provide creditor protection (varies with states).

5. SPIAs can be purchased directly without a saleman's high commission. Rates can be compared and are competitive.

I speak from experience. We purchased 2 SPIAs about age 80. We have no worry about bear markets or outliving our income (similar to pensions and social security).

P.S. Most annuities (other than SPIAs) should be avoided.
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: With interest rates so low, are annuities effectively de

Post by alec » Mon Dec 27, 2010 10:28 pm

Lbill wrote:A part of my retirement investing strategy was to purchase one or more single premium fixed income annuities at about this point in time. However, interest rates have collapsed for annuities. Some commentaries I've been reading lately suggest buying an annuity comes close to committing financial suicide, because you would be locking in next-to-nothing interest rates for eternity. I'm wondering what others are thinking, and if anyone thinks purchasing a life annuity still makes any sense and why?
Well, if you want to use matching strategies, you can either do bond ladders with bonds at the current yields or buy a life annuity based on current bond yields. Either way, you "lock in" today's low yields. But them's the brakes. Not much you can do about this.

Why exactly doing either of the above financial suicide?
"It is difficult to get a man to understand something, when his salary depends upon his not understanding it!" - Upton Sinclair

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Re: With interest rates so low, are annuities effectively de

Post by dkturner » Tue Dec 28, 2010 12:09 pm

Lbill wrote:A part of my retirement investing strategy was to purchase one or more single premium fixed income annuities at about this point in time. However, interest rates have collapsed for annuities. Some commentaries I've been reading lately suggest buying an annuity comes close to committing financial suicide, because you would be locking in next-to-nothing interest rates for eternity. I'm wondering what others are thinking, and if anyone thinks purchasing a life annuity still makes any sense and why?
Any product, investment or otherwise, that generates the level of commission income that annuities provide is never going to die, at least not of natural causes.

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SPIA commissions?

Post by Taylor Larimore » Tue Dec 28, 2010 12:32 pm

Hi dkTurner:
Any product, investment or otherwise, that generates the level of commission income that annuities provide is never going to die, at least not of natural causes.
What is the level of commission for a SPIA bought directly from the insurance company or through an agent?

Thank you and Happy Holiday!
Taylor
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Re: SPIA commissions?

Post by Ron » Tue Dec 28, 2010 12:38 pm

Taylor Larimore wrote:What is the level of commission for a SPIA bought directly from the insurance company or through an agent?

Taylor
While I know the answer, I think you are being mean :twisted: ...

OK, you can have some fun with this one...

- Ron

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Re: With interest rates so low, are annuities effectively de

Post by ndchamp » Tue Dec 28, 2010 12:43 pm

dkturner wrote: Any product, investment or otherwise, that generates the level of commission income that annuities provide is never going to die, at least not of natural causes.
I thought SPIA's were the subject of this thread. :?:

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Re: With interest rates so low, are annuities effectively de

Post by bob90245 » Tue Dec 28, 2010 12:49 pm

Lbill wrote:... I've been reading lately suggest buying an annuity comes close to committing financial suicide, because you would be locking in next-to-nothing interest rates ...
If you can generate a higher income stream , albeit with more risk, from your mix of stocks and bonds, why not do that instead?
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: With interest rates so low, are annuities effectively de

Post by alec » Tue Dec 28, 2010 12:54 pm

bob90245 wrote:If you can generate a higher income stream , albeit with more risk, from your mix of stocks and bonds, why not do that instead?
And how can one generate a higher income stream from a mix of stocks and bonds?
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Re: With interest rates so low, are annuities effectively de

Post by Gill » Tue Dec 28, 2010 12:56 pm

ndchamp wrote:I thought SPIA's were the subject of this thread. :?:
Truthfully, I haven't been sure from the beginning... :?
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Post by Beagler » Tue Dec 28, 2010 1:08 pm

@Ron, how did you go about choosing among the various insurance companies?

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Re: With interest rates so low, are annuities effectively de

Post by bob90245 » Tue Dec 28, 2010 1:31 pm

alec wrote:
bob90245 wrote:If you can generate a higher income stream , albeit with more risk, from your mix of stocks and bonds, why not do that instead?
And how can one generate a higher income stream from a mix of stocks and bonds?
I'm not the one making the decision to choose between a fixed immediate annuity destined to "come close to committing financial suicide" and a mix of stocks and bonds. But I assume under that circumstance, a mix of stocks and bonds would be better.

I haven't run the numbers lately. But I assume Lbill has, and can better assess his situation and make the appropriate choice.



Edit1: Added link for quote attribution
Last edited by bob90245 on Tue Dec 28, 2010 3:28 pm, edited 1 time in total.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Post by Ron » Tue Dec 28, 2010 1:52 pm

Beagler wrote:@Ron, how did you go about choosing among the various insurance companies?
Since you asked/..

I started researching (including Bob's site :lol: ) the various types of annuities and what was best for our (me/wife) retirement plan, based upon our desired income, including deferral of SS income, spousal income SS claims, and personal income based upon two (small) defined benefit plans for my wife (e.g. pension), along with my small VA disability income.

After determining that an SPIA was what we needed, to fit our specific needs (subject to terms), I used the following:

http://www.immediateannuities.com/

To get an idea of the options available. Since VG and FIDO (our other major retirement portfolio holder) were not on this list, I requested a quote from them, with specific terms.

If you have read my previous posts on the subject, you will see that our primary concern was not inflation, but what we could get at the maximum (under our minimum terms) monthly payment, in order to maximize our SS claims. Remember, I retired at age 59 and did not expect to file my claim for SS till age 70 - an 11 year span. I needed something (beyond my investments) to act as an income source (e.g. a pension) during this time, and I wanted to get the "most" as far as monthly income.

As in all things, all "options" you add do cost you money. Life annuities (our primary concern), along with inflation adjustment, guaranteed length of contract, survivor benefits, etc. all have a "price". You need to try to define your requirements, request the quote (with your requirements) and see what the results are.

At the time, FIDO offered the best monthly rate. We requested a contract, and were ready to sign (upon review). I suddenly got a call from FIDO to inform me that one of their vendors had just increased their rate (it does change, week to week) and that I should not sign the contract. They Fedex'ed me a new contract (overnight) with the improved terms. We signed the contract and submitted it (subject to a two-week review).

You can't say that any one company is "the one". You must define your terms, and search for what is the best for your situation.

In our case, we wanted a policy (an SPIA is an insurance policy) to provide us a set amount for early retirement income, that would assist us in delaying SS (when we could "trade up" to a superior inflation adjusted product).

We also were concerned about maintaining an amount on a consistent basis, regardless if one of us would pass (our payments continue at 100%, regardless if one would pass).

We also were concerned about "giving our money to the insurance company" if we passed before we received our total benefits. In our case, we have a life benefit, with a guaranteed term. What that means is that we receive a certain amount (as long as one is alive). If we both pass? Payments continue to our estate. If we live longer than the guarantee period (highly unlikely), payments continue at 100%.

Every annuity (e.g. SPIA) is based upon certain criteria. IMHO, you must first define what you need - then search for a matching product.

BTW, for those that are wondering, our total return from our SPIA will be at least 2x the policy purchase "price" at the time. While not adjusted for inflation, it was "good enough" to meet our plan of delaying SS, along with having a minimul return. Of course, if we "beat the odds" and live longer than the guaranteed period, our ROI will increase, month by month. When we start SS, the SPIA will just act as "icing on the cake".

Anyway, that's what our "process" was.

- Ron

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Post by gw » Tue Dec 28, 2010 4:04 pm

Interest rates may not matter as much as you think, because most of the payout comes from return of principal.

Here's a pretty good estimate of the payout from an immediate annuity:

(annuity yield) = 1 / (life expectancy) + (interest rate) / 2

To see that it's a good estimate, compare that formula with a quote from Berkshire Finance Corp., which can be obtained at:

http://www.brkdirect.com/spia/EZQUOTE.ASP

For a 65-year-old male, BHFC offers a fixed immediate annuity with a yield of 7.3%. They say this is based on a U.S. treasury yield of 3.61% along with unspecified mortality assumptions.

We can deduce their mortality assumptions by plugging 7.2% and 3.61% into an annuity calculator, like this one:

http://www.moneychimp.com/calculator/an ... ulator.htm

Apparently, the 7.3% yield results from an interest rate of 3.61% along with a life expectancy (payout period) of about 18 years. Not coincidentally, 3.61% is close to the 10-year treasury yield.

Our estimate for the payout from an 18-year annuity with 3.6% interest is pretty good: 1/18*100 + 3.6/2 = 5.6% + 1.8% = 7.4%

You can see that the interest rate on the underlying investment is relatively unimportant --- it's mortality that matters. If the 10-year treasury yield rose from 3.6% to 5.6%, it would be the highest rate in a decade (see, eg., http://fixedincome.fidelity.com/fi/FIHistoricalYield), but it would only increase the annuity payout from 7.3% to around 8.3%.

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Post by bobcat2 » Tue Dec 28, 2010 4:38 pm

I'm not the one making the decision to choose between a fixed immediate annuity destined to "come close to committing financial suicide" and a mix of stocks and bonds. But I assume under that circumstance, a mix of stocks and bonds would be better.
I just got a quote from Vanguard's Income Solutions for a 65 year old male purchasing an inflation-indexed life annuity. The real payout rate is approximately 5.25%, or roughly 31% higher than a 4% SWR from a mix of stocks and bonds. This is hardly coming close to committing financial suicide.

IIRC about three years ago the real payout rate for a 65 year old male purchasing an inflation-indexed life annuity was just over 6%, so the payout has diminished as LT real rates have declined, but not dramatically so.

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Post by beareconomy » Tue Dec 28, 2010 4:43 pm

Just for my curiousity, what happens if the annuity company goes out of business, or you only insured for $100k by the state. Is it better to use a bunch of companies? I'm 31, so I have no need for these for hopefully a long time.

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Post by bob90245 » Tue Dec 28, 2010 5:01 pm

beareconomy wrote:Just for my curiousity, what happens if the annuity company goes out of business, or you only insured for $100k by the state. Is it better to use a bunch of companies?
You should be covered by staying under the limits for your State Guaranty Association which are $100K, $200K, $300K or $500K per insurer or $250K, $300K or $500K in the aggregate for all lines of annuity contracts. Hint: Move and retire to Washington state. :lol:

http://www.fsdfinancial.com/State%20Gua ... ations.htm
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Post by Beagler » Tue Dec 28, 2010 5:27 pm

@ Ron, thank you very much for your detailed answer. It's clear a lot of thought went into this important decision.

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Re: SPIA commissions?

Post by dkturner » Tue Dec 28, 2010 5:28 pm

Taylor Larimore wrote:Hi dkTurner:
Any product, investment or otherwise, that generates the level of commission income that annuities provide is never going to die, at least not of natural causes.
What is the level of commission for a SPIA bought directly from the insurance company or through an agent?

Thank you and Happy Holiday!
Taylor
It obviously varies from company to company Taylor, but here's some information you might find helpful.

http://www.retireearlyhomepage.com/annuity_costs.html

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Post by dpbsmith » Tue Dec 28, 2010 6:47 pm

Certainly lower interest rates make SPIAs less attractive than before. But "effectively dead" is strong language and I don't see it.

* Planning should be on an absolute basis, not a relative basis--if an annuity meets a need that you can't meet better in some other way, then you should use it even if there was some other time when annuities were better.

* Annuities should be compared to conservative investments; the same factors that make annuities less attractive make the alternatives less attractive, too.

* The whole point of an annuity is that the payouts derive from risk pooling, from "mortality credits," and not just investment earnings of the underlying assets; that's why an annuity is not an investment. The older you are when you buy the annuity, the smaller the fraction of the payouts that come from investment earnings and the larger that come from the "insurance" aspect, and transfers from less fortunate to more fortunate annuitants. For older buyers, the mortality credits actually predominate. Based on a life table I calculated that an SPIA can pay a 75-year-old man 8% of the premium per year even if the interest rate is zero. That 8% isn't to be misunderstood as investment earnings--it's mostly return of principal--but it pays bills just as well as investment earnings do.

Greaney's "cost" analysis

Greaney's analysis of the "cost" of an annuity is interesting, and it is what it is. But I think it is inappropriate to count adverse selection as a "cost." It is a cost only in a relative sense--voluntarily purchased annuities attract healthier purchasers than Social Security, which covers everyone, so voluntarily purchased annuities cost more. Certainly, the SS-521 "do-over," when it was available, was a better deal than commercial annuities. One reason why it was a better deal is that it allowed voluntary buy-in to the Social Security system; to the extent that those opting to do it were healthier than the general population, they were, in fact, profiting at the expense of the rest of Social Security participants.

"Adverse selection" is not a fee, hidden or otherwise, and does not flow into the coffers of the insurance companies.

Finally, while noting that this comes from an interested source, a Vanguard paper, Generating Guaranteed Income: Understanding Income Annuities, has "money's worth" figures that differ considerably from Greaney's. From page 10:

Image

Whom should we believe? I don't know. Probably Greaney because he isn't selling annuities (nor do I, just for the record), but with the proviso that I really don't think "adverse selection" should be counted among the costs--especially since there is no alternative now that Social Security "do-overs" have been eliminated.

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Re: With interest rates so low, are annuities effectively de

Post by crefwatch » Wed Dec 29, 2010 8:01 am

ndchamp wrote:I thought SPIA's were the subject of this thread. :?:
Prevailing interest rates also affect annuities purchased through payroll plans, like TIAA-CREF and various union supplemental-retirement plans. (TIAA Traditional is a particularly good comparison, because it is similar to an SPIA bought a month at a time. But their equity-linked annuities [generally without guaranteed payout minimums!] also deserve consideration.)

While some employer plans have lower costs than SPIAs, the primary issue being discussed here should be whether any annuity provides a useful and appropriate income source for any individual client. Financial services aren't given away for free.

It's strange to read (in a forum where Safe Withdrawal Rates are constantly lamented) that an option with zero risk of outliving income and a payout exceeding the SWR at any age should not be considered! Emotionally, the "bet" with the issuing company bothers a lot of retirees. But like a host of other investment emotions, it need to be put out in the open and dealt with in an adult way.

(I have no connection with the financial services industry. I'm a retired stagehand.)

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Re: With interest rates so low, are annuities effectively de

Post by alec » Wed Dec 29, 2010 8:13 am

crefwatch wrote:It's strange to read (in a forum where Safe Withdrawal Rates are constantly lamented) that an option with zero risk of outliving income and a payout exceeding the SWR at any age should not be considered! Emotionally, the "bet" with the issuing company bothers a lot of retirees. But like a host of other investment emotions, it need to be put out in the open and dealt with in an adult way
I know, don't you just hate it. :D
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Post by alec » Wed Dec 29, 2010 8:43 am

dpbsmith,

It appears that the money's worth calcs in the vanguard paper above are based on Treasury yields, not corporate bond yields [like Greaney's].
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Post by sscritic » Wed Dec 29, 2010 8:59 am

Interest rates are low, but people haven't stopped dying.

What you get from an annuity is a return of your own money and some of the money of all the people who die before you do. Neither depends on interest rates (admittedly, the growth of those two parts does).

High interest rates mean you get a little more from the earnings, but they don't change the basic equation.

Now we need a study of whether low interest rates lead to premature death (not yours, all those other people). :)

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Post by Ron » Wed Dec 29, 2010 9:06 am

sscritic wrote:Now we need a study of whether low interest rates lead to premature death (not yours, all those other people). :)
I'll set up a poll; everybody who died due to low interest rates, please raise your hand :lol: ...

- Ron

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Post by Ron » Wed Dec 29, 2010 10:21 am

sscritic wrote:What you get from an annuity is a return of your own money and some of the money of all the people who die before you do.
Here's a related article/graph to illustrate what you are saying:

https://news.fidelity.com/news/article. ... -annuities

- Ron

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Post by grayfox » Wed Dec 29, 2010 11:17 am

gw wrote:Interest rates may not matter as much as you think, because most of the payout comes from return of principal.

Here's a pretty good estimate of the payout from an immediate annuity:

(annuity yield) = 1 / (life expectancy) + (interest rate) / 2

To see that it's a good estimate, compare that formula with a quote from Berkshire Finance Corp., which can be obtained at:

http://www.brkdirect.com/spia/EZQUOTE.ASP

For a 65-year-old male, BHFC offers a fixed immediate annuity with a yield of 7.3%. They say this is based on a U.S. treasury yield of 3.61% along with unspecified mortality assumptions.

We can deduce their mortality assumptions by plugging 7.2% and 3.61% into an annuity calculator, like this one:

http://www.moneychimp.com/calculator/an ... ulator.htm

Apparently, the 7.3% yield results from an interest rate of 3.61% along with a life expectancy (payout period) of about 18 years. Not coincidentally, 3.61% is close to the 10-year treasury yield.

Our estimate for the payout from an 18-year annuity with 3.6% interest is pretty good: 1/18*100 + 3.6/2 = 5.6% + 1.8% = 7.4%

You can see that the interest rate on the underlying investment is relatively unimportant --- it's mortality that matters. If the 10-year treasury yield rose from 3.6% to 5.6%, it would be the highest rate in a decade (see, eg., http://fixedincome.fidelity.com/fi/FIHistoricalYield), but it would only increase the annuity payout from 7.3% to around 8.3%.
This is a good analysis.

Base on this, it sounds like lower interest rates DO NOT mean that annuities are essentially dead. Maybe not as great a deal as some times in the past, but when rates and expected returns are low they are low for everything including your stock and bond portfolio.

Speaking of essentially dead, one thing I like about the idea of an immediate annuity, is that if you are the kind of person that likes to get his money's worth, there is an incentive not to become dead.
Last edited by grayfox on Wed Dec 29, 2010 11:28 am, edited 1 time in total.

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Post by sscritic » Wed Dec 29, 2010 11:26 am

grayfox wrote:
gw wrote: Here's a pretty good estimate of the payout from an immediate annuity:

(annuity yield) = 1 / (life expectancy) + (interest rate) / 2
This is a good analysis.

Base on this, it sounds like lower interest rates DO NOT mean that annuities are essentially dead. Maybe not as great a deal as some times in the past, but when rates and expected returns are low they are low for everything including your stock and bond portfolio.
Intuitively, if you are going to live 18 more years, you should get 1/18 of your own money back each year. If your money is earning interest, on average it is earning it for only 9 years (or on average, only half of your money is on deposit, i.e., half has already been returned and half is still earning interest).

Plugging in 0% gets you 5.56%; 2% gets you 6.66%; and 4% gets you 7.66%.

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Post by gw » Wed Dec 29, 2010 1:47 pm

sscritic wrote: Intuitively, if you are going to live 18 more years, you should get 1/18 of your own money back each year. If your money is earning interest, on average it is earning it for only 9 years (or on average, only half of your money is on deposit, i.e., half has already been returned and half is still earning interest).
Exactly.

If you look at longer periods of time or higher interest rates, you should throw in a correction for compounding interest, but in this case it doesn't really matter.

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Post by RustyShackleford » Wed Dec 29, 2010 5:29 pm

Just did a quote on an CPI-adjusted one for myself, and the initial WR was about the same as for the one I bought almost 4 years ago. Of course, I'm 4 years older ... (For the record, the number was 4.4% in both cases, and I'm now a 58yo male; I was still male, but 54yo, on the previous one).

Still, is there any reason to hurry into buying a SPIA ? Does it not make sense to wait for interest rates to rise ?

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Post by RustyShackleford » Wed Dec 29, 2010 5:34 pm

Here's a pretty good estimate of the payout from an immediate annuity:

(annuity yield) = 1 / (life expectancy) + (interest rate) / 2
Is this for a "flat" one, a CPI-adjusted one, or what ?

What life-expectancy tables are used ?

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Post by dpbsmith » Wed Dec 29, 2010 7:42 pm

gw wrote: Here's a pretty good estimate of the payout from an immediate annuity:

(annuity yield) = 1 / (life expectancy) + (interest rate) / 2
sscritic wrote:Intuitively, if you are going to live 18 more years, you should get 1/18 of your own money back each year. If your money is earning interest, on average it is earning it for only 9 years (or on average, only half of your money is on deposit, i.e., half has already been returned and half is still earning interest).
Exactly. If you look at longer periods of time or higher interest rates, you should throw in a correction for compounding interest, but in this case it doesn't really matter.
gw, that is a very cool observation. I independently arrived at sscritic's rationale. It makes perfect sense
Ron wrote:
sscritic wrote:What you get from an annuity is a return of your own money and some of the money of all the people who die before you do.
Here's a related article/graph to illustrate what you are saying:

https://news.fidelity.com/news/article. ... -annuities
And that's a cool chart, even if I don't understand why there's a water molecule at the top. To save people the trouble of clicking the link:
Image

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Post by alec » Fri Dec 31, 2010 6:02 pm

RustyShackleford wrote:Just did a quote on an CPI-adjusted one for myself, and the initial WR was about the same as for the one I bought almost 4 years ago. Of course, I'm 4 years older ... (For the record, the number was 4.4% in both cases, and I'm now a 58yo male; I was still male, but 54yo, on the previous one).

Still, is there any reason to hurry into buying a SPIA ? Does it not make sense to wait for interest rates to rise ?
Hey Rusty,

Since no one replied to your question(s) yet, I thought I'd take a stab. It appears that you're saying that you are more or less in a worse off position today [so to speak] b/c even though you've aged the payout per $$ of the inflation adjusted life annuity is the same. And that if interest rates rise, the payout per $1 of the inflation adjusetd life annuity will rise, so you should wait for this to happen.

However, I'd argue that you're roughly in the same position no matter what interest rates do, and here's my reasoning FWIW:

4 years ago, you'd likely have taken some of your bonds, sold them at market prices, and annuitized the proceeds. Instead you kept the bonds. Now that interest rates have fallen, the payout per $$ is less than it was relatively speaking. However, the market value of your bonds is now higher than it was now that interest rates have fallen, so instead of having say $100,000 in bonds to annuitize, you now have say $120,000 in bonds to annuitize. Thus, you can probably buy the same amount of life annuity income now as if interest rates hadn't changed!

For example, let's say that 4 years ago a 58 yr old could buy a $5,000 inflation adjusted life annuity for $100,000, and now it would cost say $125,000 for the same $5,000 life annuity for a 58 yr old. Well, lucky for you that $100,000 that you put in bonds 4 years ago is now worth $125,000!

Likewise, if interest rates rise, the payout per $$ of the life annuity should rise compared to today, but the market value of your bonds that you plan on selling to fund the annuity will fall compared to today. Hence you won't be much better or worse off.

The bonds you already own hedge the risk that future interest rate movements will adversely affect the payout of the life annuity.
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Post by RustyShackleford » Sat Jan 01, 2011 3:20 pm

Interesting thoughts, Alec, thanks. Makes sense I guess.

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Post by Bongleur » Sat Jan 01, 2011 11:48 pm

I've just spent the day reading various articles by Milevsky:

http://www.ifid.ca/research.htm

And one of them quantified the benefit at any age of delaying annuity purchase. The odd thing is that its beneficial if you are in the hole because its cheaper tomorrow and you can't afford it today. Its also cheaper if you don't truly need it now, because its cheaper tomorrow.

IIRC until age 84 or 85 its always better to delay.

Skim over the calculus and look for the explanatory bits in the text, or skip to the end for the charts & tables, then go back to find the explanatory parts in the text.

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Post by Bongleur » Sun Jan 02, 2011 12:22 am

Is the SS-521 do over repealed for 2011? Morningstar was explaining its usefulness just list July:

http://news.morningstar.com/articlenet/ ... ?id=343967

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Post by kramer » Sun Jan 02, 2011 4:00 am

A guaranteed lifetime stream of income is worth more to the purchaser, relative to the purchase price, as you get older.

Precisely speaking, it is worth more as the ratio of the standard deviation of your life expectancy divided by your life expectancy increases.

In effect, it is mitigating more mortality risk as you get older.

This is a free lunch except for the huge fact of adverse selection.

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Post by jack1719 » Sun Jan 02, 2011 6:58 am

I disagree with the line annuity is best for 80 year olds...I think it best for someone who reaches the average retirement age of 61 in the USA...someone who lives to be 61 has a VERY good chance of living to 85 years old....the stats then are in your favor more than against you to live to that age...

annuity is all about longevity protection

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Post by sscritic » Sun Jan 02, 2011 9:45 am

Bongleur wrote:Is the SS-521 do over repealed for 2011? Morningstar was explaining its usefulness just list July:

http://news.morningstar.com/articlenet/ ... ?id=343967
Here is a result of a search for SS-521 in the bogleheads.org search box.
http://www.google.com/search?q=ssa-521& ... eheads.org

Look for a recent article with the words "change," "social security," and "rules" in it.

The first post was dated December 8, 2010. The second post by ThePrune has a link to the official word.

P.S. Did your question really belong in a thread about annuities?

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Milevsky-annuitization at one time is sub-optimal

Post by bobcat2 » Sun Jan 02, 2011 9:54 am

From Financial Education and Annuities by Jeffrey Brown
Of course, actuarially unfair pricing may not simply result in consumers deciding not to purchase an annuity at all: it may also lead consumers to delay annuitization. If prices are higher than actuarially fair levels, Milevsky and Young (2007) show that there may be advantages to delay. For example, it may be optimal to delay annuitization if returns on investment in the future might exceed current returns or if annuities purchased later in life are priced more favorably than those purchased earlier. Relatedly, they show that an "all-or-nothing" annuitization decision at a single point in time is sub-optimal, and that most consumers would be better off initially annuitizing a lump sum (if they do not already have this minimum level from pre-existing defined benefit pensions like Social Security) and then gradually purchasing additional life annuities over time.
Link to J. Brown paper.
http://www.google.com/#sclient=psy&hl=e ... 155c57878e


From the conclusion section of paper, Annuitization and Asset Allocation by Milevsky and Young.
Thus, in contrast to the all-or-nothing pension structure, in the case of an open system where annuities can be purchased on an ongoing basis, we find that individuals prior to age 70 should have a minimal amount of annuity income and should immediately annuitize a fraction of wealth to create this base level of lifetime income if they do not already have thi from pre-existing defined benefit pensions. We reiterate that individuals should always hold some annuities, even in the presence of a bequest motive, as long as z0(t) in Proposition 6.2 is less than infinity.
Link to paper - http://www.google.com/#hl=en&expIds=172 ... 155c57878e

In other words annuitized income from all or nothing sources, SS and DB pensions, in many instances should be delayed if the option to delay is available. But optimal purchases of private life annuities should be purchased on an ongoing basis beginning at retirement to establish a base level of retirement income. Far too many people are taking what Milevsky has to say about all or nothing annuitization from SS and DB pensions and applying it to private annuitization purchases.

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SPIA insurance and moving to Canada

Post by VictoriaF » Sun Jan 02, 2011 10:29 am

If a U.S. resident buys an SPIA, later moves to live in Canada, and the issuing insurance company fails -- would he be eligible for the state insurance guarantee?

What happens when people move to different U.S. state(s) years after they have bought an SPIA. Are there any states that provide more encompassing guarantees than others? Could states change their coverage guarantee later, e.g., from $300,000 to $100,000?

The http://www.nolhga.com/ site has state-specific links, but they are not a user-friendly reading. Are there better sources or summaries?

Thank you,

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Post by namaste » Sun Jan 02, 2011 5:25 pm

#Cruncher wrote:bobcat2's advice seems sound to me.

If you want some more information about annuities and how they fit into a retirement plan, I suggest Jim Otar's Unveiling the Retirement Myth. Chapters 33-36 discuss the various types. And chapters 41-44 discuss their roll depending on how well (or poorly) your retirement is funded: what he calls the Green, Gray, and Red zones.

For a limited time you can download a PDF copy for free: http://www.retirementoptimizer.com/
Thank you so much for this link. It has me thinking a bit more about my allocation strategy as well.

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Re: SPIA insurance and moving to Canada

Post by dpbsmith » Mon Jan 03, 2011 7:10 am

VictoriaF wrote:If a U.S. resident buys an SPIA, later moves to live in Canada, and the issuing insurance company fails -- would he be eligible for the state insurance guarantee?
That's a very interesting question. The answer is probably "no."
What happens when people move to different U.S. state(s) years after they have bought an SPIA.
Insurance is state-regulated so the laws are different in each of the fifty states, although they follow very similar patterns because undoubtedly the state legislators were advised by the same industry groups. But it seems to be generally true that you are protected by the state guaranty association of the state in which you reside at the time when the insolvency occurs. That is, it is not at ALL like a little insurance policy that your state issues concurrent with the annuity itself. It is like an ongoing here-and-now thing.

Your insurer fails? It doesn't matter where you were when you bought the policy, if you live in Illinois it's up to the Illinois guaranty association to take care of you.

My lay reading of the law for several states seemed to make it clear that it all depends your state of residence at the time of insolvency, and that, yes, theoretically if you suspected your insurer was about to fail you could move to a state with higher protection limits.

With regard to Canada, I think you're unprotected, unless there are Canadian provincial guaranty associations or something like that. I think if your insurer failed while you were residing in Canada--mind you, the word is "reside" and a lawyer once explained to me the difference between "residence" and "domicile" and I didn't get it, complex legal stuff here--the Illlinois state guaranty association would say "Not our problem, we protect people who live in Illinois" and ditto for all the rest of them. But maybe there's other language in the state laws that covers that case.
Are there any states that provide more encompassing guarantees than others?
Absolutely. California is the worst, protecting only 80% of the value (every other protects full value) and only up to $100,000. New York and some others protect up to $500,000. There are other differences as well.
Could states change their coverage guarantee later, e.g., from $300,000 to $100,000?
I think they could at the drop of a hat. It's just a state law that says what insurers must do for an insolvency today; no promises for the future. And it doesn't spell it out precisely what must be done in any very specific way, there is great scope for the guaranty association to handle it on a case-by-case basis.

I hadn't thought about the "change the rules" aspect of it, but that is probably one of the reasons why a state division of insurance rep corrected me in a phone conversation every time I referred to the protection as "insurance" and was insistent that the protection is "not insurance." Note that NOLHGA consistently refers to it as "safety net."

I think it's meaningful protection--your insurer fails, there's this state law that says you have a legal right to call on the guaranty association to... do... something. But it's not at all the same kind of thing as, say, FDIC deposit insurance.

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Post by dpbsmith » Mon Jan 03, 2011 7:45 am

Bongleur wrote:I've just spent the day reading various articles by Milevsky:

http://www.ifid.ca/research.htm

And one of them quantified the benefit at any age of delaying annuity purchase. The odd thing is that its beneficial if you are in the hole because its cheaper tomorrow and you can't afford it today. Its also cheaper if you don't truly need it now, because its cheaper tomorrow.

IIRC until age 84 or 85 its always better to delay.

Skim over the calculus and look for the explanatory bits in the text, or skip to the end for the charts & tables, then go back to find the explanatory parts in the text.
I'm not sure what Milevsky does and doesn't say, but I think you are mistaken in your interpretation. I looked into this once in some detail. People get confused because the payout rises sharply with age, but that doesn't tell you that you are getting a better deal, most of that is just the "1 / remaining life expectancy effect."

I once spent hours doing actual calculations with actual annuity quotations, and what I found is that in theory it is always slightly better to annuitize early. It is all about the mortality credits--see the Fidelity chart--and even at age 65-70 they are not zero. If you annuitize at age 70 instead of age 65 you miss out on the thin little green wedge.

What I did was to compare scenario A, in which you buy a $100,000 annuity at (say) age 65, with scenario B, in which you invest $100,000 in bonds, draw the same amount of income from the bond portfolio as the annuity would have paid out, and then use what is left of the bond portfolio to buy an annuity at age 70. The only assumption, admittedly a big one, was that you can get the same annuity terms five years from now as a 70-year-old can get today.

The result of drawing the same income from the bond portfolio is that the value of the bond portfolio declines. But the payout percentage at age 70 is higher than it was at age 65. So it's not intuitively clear what will happen; you are getting a higher percentage payout of a smaller premium. But I got absolutely unvarying, uniform results: the increased payout percentage was never enough to fully offset the spend-down of the bond portfolio. And I am sure this is a direct reflection of the loss of the mortality credits by delaying annuitization.

That said, at younger ages the difference was so small that a person could choose to regard it as negligible. Or lost in the noise. Or possible to overcome by making very slightly riskier investments than the insurer makes.

If Milevsky found something different, it can only be that he was factoring in economist-handwaving-things like opportunity cost or risk aversion or psychological "utility functions." I know my basic conclusion is right, because Milevsky himself developed something called the "implied longevity yield," which I didn't learn about until after I did my spreadsheet tinkering, which basically amount to the same thing.

In the Bogleheads' Guide to Retirement Planning, I phrased it this way: "In a world where you could be confident in your decision to commit funds to an annuity, where the price of an annuity never fluctuated, and where there was no risk of insurer default, the earlier you annuitized, the better." It is a balancing act in which you weigh off some imponderable factors on one side, against some fairly hard numbers at the other side... and the hard numbers are close to zero but slightly positive even at age 65, and increase very sharply until they become huge by, say, age 80.

The other key point is that "opportunity cost" depends on the opportunity. What, exactly, are you going to do with the money if you don't annuitize it? What my spreadsheet exercises showed is clear. If all you are going to do with it is invest it conservatively like the insurance company does, and draw income from it just like you would be drawing from the annuity, you are always better off annuitizing earlier; the only question is when the difference grades from "negligible" into "meaningful."

I see only two benefits from "retaining control." One is the possibility of using it for higher-yielding riskier investments ("Sorry, Sam, I'd can't go shares with you in your new restaurant, oh, if only I hadn't given all that money to the annuity company"). Another is retaining the emergency reserve ("My health insurance won't cover these experimental treatments and I can't pay for them... oh, if only I hadn't given all that money to the annuity company.")

The green in the Fidelity chart really tells the story nicely. The earlier you annuitize, the more of the green you capture. If you defer, the green represents the cost of not annuitizing it. But there is so little to capture early on that a sane person might consider it negligible--or as being negated by whatever dollar value can be placed on "loss of control."

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