Why not use inflation-adjusted SPIA?

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dhodson
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Re: Why not use inflation-adjusted SPIA?

Post by dhodson »

toto238 wrote:
dhodson wrote:That return includes return of principle

Costs drag the return also selection bias since only healthy buy it. They actually use different tables than life insurance.

Inflation ones give a much lower initial payout

They are however in my opinion good for some portion around age 80 when mortality credits increase

I'd however buy a non inflation product
How much of it is "return of principle" is irrelevant. It's not an investment. You're purchasing an income stream that's guaranteed against inflation.

And yeah, inflation-adjusted gives a lower payout. a 65-year-old could get 4.5% to 5% inflation adjusted, but non-inflation-adjusted they could get closer to 6.5 to 7%.

But I'm not comparing it to something that can't adjust for inflation. I'm comparing it to something that is supposed to be adjustable to inflation, like the SWR of 4%.
It's not irrelevant. Most people likely need to grow their money to have a decent retirement and a steady stream isn't helpful if you want to or need to make a large purchase/expense. Heck tons of people can't even defer SS which really is the first choice. These things are great if you truly need the guaranteed income but otherwise it's not a hidden treasure. For the people on the upper end, they probably will be fine with or without. I'm planning on a non inflation spia at age 80 for basic needs.
555
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Re: Why not use inflation-adjusted SPIA?

Post by 555 »

toto238 wrote:"If you don't have enough for the I-SPIA to cover that, then you didn't save enough."
That's basically right, but the way to use that is get a ball-park figure of how much you need to accumulate to be able to retire, (which depends on age of course, and it depends if it's single or couple).

But once you have determined that you have enough, there are many options, and you can combine these options to diversify. The various kinds of "good" annuities (not bad, not ugly) are just part of a wider menu of investments that you may choose if/when needed/wanted.
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Re: Why not use inflation-adjusted SPIA?

Post by itstoomuch »

I recently asked and received information from ImmediateAnnuities.com , Hersh Stern Agency.
I didn't look too hard at the I-SPIAs. Quotes are good as of Dec 01, 2014.
@55 Male 3% I-SPIA, single life with remainder insurance = 64% of SPIA
@60 = 69%
@65 = 73%
@70 = 76%
@80 = 82%
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BetaTracker
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Re: Why not use inflation-adjusted SPIA?

Post by BetaTracker »

Does this strike you as interesting? I just came across this -- apparently a Medicaid compliant single-premium immediate annuity can be used to protect assets over what Medicaid allows to be covered. Here's an article showing how a couple used this type of annuity to divert income for the wife after her husband had to go into a nursing home. Just wondering -- if you get an immediate annuity now, could you be jumping the gun and not using it strategically enough?
http://www.fa-mag.com/news/sales-of-nur ... 20997.html
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Re: Why not use inflation-adjusted SPIA?

Post by patrick »

toto238 wrote: The insurance company can absolutely buy TIPS. And therefore are just as safe if inflation "takes off" as Social Security, since both Social Security and TIPS are in the end guaranteed by the Government of the United States of America.

An insurance company can take 100% of assets collected for these annuities and put them into TIPS. They have then eliminated the risk that runaway inflation will hurt them in any way, shape, or form. If inflation increases by 10%, all their TIPS will have gone up in value by 10%. Thus, no problem.
They can do this for the most part, but there is still some interest rate risk. Some of the people who buy the annuity will live longer than 30 years. How can the insurance company hedge the inflation risk involved in payments that need to be made 35 years from now? There are no 35-year TIPS on the market now, so the insurance company will need to reinvest at some point. What if real interest rates fall dramatically before 2050-maturing TIPS are issued?
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plannerman
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Re: Why not use inflation-adjusted SPIA?

Post by plannerman »

toto238 wrote:... and on the other hand you run the risk of having a huge amount of money leftover that doesn't do you any good. If your balance doubles, you're not doubling what you're paying yourself. You're just giving yourself the COLA that you planned on. So anything above that you can't touch...."
You certainly can more than double what you are paying yourself. Your portfolio has doubled, you are now older and have a shorter life expectancy. Just recalculate a new SWR.

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Johno
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Re: Why not use inflation-adjusted SPIA?

Post by Johno »

patrick wrote:
toto238 wrote: The insurance company can absolutely buy TIPS. And therefore are just as safe if inflation "takes off" as Social Security, since both Social Security and TIPS are in the end guaranteed by the Government of the United States of America.

An insurance company can take 100% of assets collected for these annuities and put them into TIPS. They have then eliminated the risk that runaway inflation will hurt them in any way, shape, or form. If inflation increases by 10%, all their TIPS will have gone up in value by 10%. Thus, no problem.
They can do this for the most part, but there is still some interest rate risk. Some of the people who buy the annuity will live longer than 30 years. How can the insurance company hedge the inflation risk involved in payments that need to be made 35 years from now? There are no 35-year TIPS on the market now, so the insurance company will need to reinvest at some point. What if real interest rates fall dramatically before 2050-maturing TIPS are issued?
The maturity limit applies about as much to non-inflation adjusted annuities (there are corporate bonds beyond 30yrs but not treasuries). Likewise the insurance company will have nominal rate risk going in both directions to very long maturities, and real rate risk tends to correlate. And there's not much likelihood that if rates fall the 30 yr point on the curve is going to fall a lot more or less than the (basically theoretical, anyway) 35 yr point. As curve risk goes that's pretty trivial. IOW you don't wait to adjust the hedge till 30 yrs go by and it's zero v 5yr curve risk.

The risk management challenge for CPI adjusted annuities isn't fundamentally different from what insurance companies do and have always done, once they have available the key building block of low risk inflation indexed bonds. So not surprisingly inflation indexed annuities have become common in various countries once their govt's started issuing significant amounts of inflation indexed debt. It happened in some other places before it did in the US.

And while financial institution risk management is an interesting topic, a career for some people, I wonder if it's possible for a discussion like this to end up in the occasional paradox of BH forum where the stock market is taken as perfectly efficient and inscrutable, whereas amateurs can for example figure out that insurance companies can't actually manage annuity risk. If amateurs could figure stuff like that out, how is it they could never come up with good trades like buying or shorting particular sectors or stocks? There's something of a disconnect if perhaps not a direct contradiction there, seems to me. Anyway if the individual is going to live a long time and not use an insurance company, then *they* have to manage long term rate risk, plus the risk of highly variable life span which I assume all can agree an insurance company is in a much better position to manage by pooling the risk of many annuitants, not to mention writing lots of life insurance policies where the risk of systematic change in longevity goes generally the opposite way.
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Re: Why not use inflation-adjusted SPIA?

Post by Bill M »

They may not be actuarially fair, and they may not be competitive, and they may be overpriced....but (in my case) they are offering a joint-100% survivor initial payout rate of 3.65%. Without any of the risks that go with the "safe" withdrawal rate, like sequence of return risk, market risk, longevity (over 30 years) risk, etc. Now if the current SWR is only 2%, these SPIAs are a bargain.

Vanguard annuity marketplace offers quotes for CPI-U annual increases, and also fixed percentage annual increases. Quotes on the CPI-U ones show the insurance companies are figuring inflation at between 2% and 3%, since the initial monthly payment is between that for a 2% fixed increase and a 3% fixed increase.
castlemodesto
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Re: Why not use inflation-adjusted SPIA?

Post by castlemodesto »

I think BetaTracker has a good point about considering a SPIA with long term care issues in mind. Purchasing the wrong type at the wrong time could make it ineligible for Medicaid purposes. Medicaid rules are very specific about what types of SPIAs are eligible. Here is a NOLO article on this
http://www.nolo.com/legal-encyclopedia/ ... anning.htm
dhodson
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Re: Why not use inflation-adjusted SPIA?

Post by dhodson »

Can someone point me to the evidence that insurance companies use TIPS for SPIAs to any large extent?
Angst
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Re: Why not use inflation-adjusted SPIA?

Post by Angst »

dhodson wrote:Can someone point me to the evidence that insurance companies use TIPS for SPIAs to any large extent?
Not sure if this helps (it doesn't specifically refer to SPIA's) but this NY Fed 2010 document states (on pg. 15) that "Insurance companies hold 2.48 percent of the TIPS and 2.96 percent of Treasury bonds." Almost as much as in Treasury bonds. Once again, no mention of SPIA's, but that's a lot of TIPS. Actually, I gather those are %'s of outstanding TIPS and TBonds, and there are a lot less TIPS out there.

http://www.ny.frb.org/research/conferen ... staff1.pdf
Independent
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Re: Why not use inflation-adjusted SPIA?

Post by Independent »

dhodson wrote:Can someone point me to the evidence that insurance companies use TIPS for SPIAs to any large extent?
First, we need to find a company that is selling "large" amounts of CPI indexed annuities. :wink:

Since sales have been lousy, I wouldn't expect to see any big chunks of TIPS on insurance company balance sheets.

The best I can do is to say that a company filing an indexed annuity of any sort is likely to include this opinion http://www.naic.org/store/free/MDL-235.pdf

It's hard to figure how a US actuary could sign off on that without referencing TIPS.

The one actuary I know who developed such a product was working with his investment dept to develop a strategy that involved TIPS or TIPS swaps. They knew what they would do initially (good enough for a filing), and some idea of how they could enhance their strategy if sales ever got high enough to justify more effort.

But, Google isn't giving me a "smoking gun" this morning.
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Kevin M
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Re: Why not use inflation-adjusted SPIA?

Post by Kevin M »

There has been very little discussion here about systemic risk of the insurance industry. What do you think about this statement by William Bernstein, from his book "The Ages of the Investor: A Critical Look At Life-cycle Investing"
While we may well avoid another crisis, particularly one that might devastate the insurance industry, I would not want to bet my retirement on it with either an immediate annuity or a deferred annuity.
Bernstein's preferred choice is a TIPS ladder. Is he just being overly paranoid? Or are we just forgetting the widespread fear of financial collapse in late 2008?

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dhodson
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Re: Why not use inflation-adjusted SPIA?

Post by dhodson »

Might want to look at the Japan insurance experience with long term low interest rate environment.
Bfwolf
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Re: Why not use inflation-adjusted SPIA?

Post by Bfwolf »

Bill M wrote:They may not be actuarially fair, and they may not be competitive, and they may be overpriced....but (in my case) they are offering a joint-100% survivor initial payout rate of 3.65%. Without any of the risks that go with the "safe" withdrawal rate, like sequence of return risk, market risk, longevity (over 30 years) risk, etc. Now if the current SWR is only 2%, these SPIAs are a bargain.

Vanguard annuity marketplace offers quotes for CPI-U annual increases, and also fixed percentage annual increases. Quotes on the CPI-U ones show the insurance companies are figuring inflation at between 2% and 3%, since the initial monthly payment is between that for a 2% fixed increase and a 3% fixed increase.
If you consider that your household costs will almost certainly decrease if you or your spouse dies, you wouldn't need to put all your I-SPIA $s into a joint 100% survivor I-SPIA. You might place 50% of your I-SPIA $s in a joint 100% survivor policy, 25% in a policy for you, and 25% in a policy for your spouse. When one of you passes away, your monthly insurance income decreases by 25%. Those numbers are just an example--you'd have to figure out what would happen to your SS income if each of you dies, and try to to get a grasp on how much expenses would change when one of you dies. But you get the idea. This would allow you to take advantage of the much higher payouts associated with single person policies compared to joint policies.
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Re: Why not use inflation-adjusted SPIA?

Post by Johno »

Kevin M wrote:There has been very little discussion here about systemic risk of the insurance industry. What do you think about this statement by William Bernstein, from his book "The Ages of the Investor: A Critical Look At Life-cycle Investing"
While we may well avoid another crisis, particularly one that might devastate the insurance industry, I would not want to bet my retirement on it with either an immediate annuity or a deferred annuity.
Bernstein's preferred choice is a TIPS ladder. Is he just being overly paranoid? Or are we just forgetting the widespread fear of financial collapse in late 2008?
A judgement call that doesn't rise to paranoid IMO, but you're not strictly taking less risk with a TIPS ladder: you're taking less credit risk in return for self-insuring against the risk of very long life. That means either a lower standard of living (consuming less while accumulating and/or while retired) which is a very real cost*, or greater risk of running out of money by living too long. The latter risk is somewhat quantifiable, relatively speaking. The risk of general insurance industry failure is harder to quantify. And all insurance co's paying *nothing* on their contracts seems very far fetched to me. Many insurance companies failing, but with relatively high recovery ratio (since ins co's are mainly piles of financial assets, unlike companies where brand value or personnel is the whole enterprise value and can evaporate on insolvency leaving creditors with almost nothing), OK that's perhaps realistic but I'd still struggle to put any particular probability on it. Which isn't to say ignore it, but you can't ignore longevity risk either.

Also, a 'high recovery rate' hair cut on investors in a US debt restructuring is not out of the question either in the long run IMO (it might be the trigger to a big ins co meltdown...), and personal Social Security statements say in black and white that only some fairly high % of promised benefits can be paid past a certain date along current trends under current law.

I don't think Bernstein is being paranoid exactly but I don't find credit risk to be a compelling argument to entirely rule out annuities, unless one's longevity risk is low (already poor health, or again somebody who positively *wants* to live on a very small annual % of their assets).

*I think the annuity discussion here often runs into the unstated goal of some BH's just to sit on a big pile of money in retirement, not ever spend it, and not accumulate it particularly to give it to someone else at death...but rather just to have it, as an end in itself. In that case a reason to only spend, eg. ~2% per year when CPI adj annuities from normal retirement pay ~4% is positively sought, not a cost or burden. But to most people, that's a huge cost.
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toto238
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Re: Why not use inflation-adjusted SPIA?

Post by toto238 »

Johno wrote: *I think the annuity discussion here often runs into the unstated goal of some BH's just to sit on a big pile of money in retirement, not ever spend it, and not accumulate it particularly to give it to someone else at death...but rather just to have it, as an end in itself. In that case a reason to only spend, eg. ~2% per year when CPI adj annuities from normal retirement pay ~4% is positively sought, not a cost or burden. But to most people, that's a huge cost.
I think there's a lot of truth to this. I'm not looking to swim in a pile of gold like Scrooge McDuck. Money is a means to an end for me only. It gives me the freedom to do the things that truly matter. Money doesn't matter. Money can be traded though for things that do matter.

I can't take it with me. I want to use every penny of it before I go. Any gifts I'd like to give before I go. All I need is inflation-proof income and an emergency fund to smooth out any bumps.
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bertilak
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Re: Why not use inflation-adjusted SPIA?

Post by bertilak »

itstoomuch wrote:Gosh, Nesaid, I imagined you to be much older. :oops:
He doesn't look very old in his picture!
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Bill M
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Re: Why not use inflation-adjusted SPIA?

Post by Bill M »

Bfwolf wrote:
Bill M wrote:They may not be actuarially fair, and they may not be competitive, and they may be overpriced....but (in my case) they are offering a joint-100% survivor initial payout rate of 3.65%. Without any of the risks that go with the "safe" withdrawal rate, like sequence of return risk, market risk, longevity (over 30 years) risk, etc. Now if the current SWR is only 2%, these SPIAs are a bargain.

Vanguard annuity marketplace offers quotes for CPI-U annual increases, and also fixed percentage annual increases. Quotes on the CPI-U ones show the insurance companies are figuring inflation at between 2% and 3%, since the initial monthly payment is between that for a 2% fixed increase and a 3% fixed increase.
If you consider that your household costs will almost certainly decrease if you or your spouse dies, you wouldn't need to put all your I-SPIA $s into a joint 100% survivor I-SPIA. You might place 50% of your I-SPIA $s in a joint 100% survivor policy, 25% in a policy for you, and 25% in a policy for your spouse. When one of you passes away, your monthly insurance income decreases by 25%. Those numbers are just an example--you'd have to figure out what would happen to your SS income if each of you dies, and try to to get a grasp on how much expenses would change when one of you dies. But you get the idea. This would allow you to take advantage of the much higher payouts associated with single person policies compared to joint policies.
Vanguard's marketplace certainly offers JS50, and JS75, in addition to JS100. Just take your pick when getting a quote.

My dad's pension was JS50. When he passed away, my Mom's expenses didn't drop by much, but the pension did. Granted the expenses could have dropped, if she had moved to a smaller apartment. I believe forced relocation is the real consequence of a JS50 (and to some extent even JS75). Social Security is already being cut on first death; I'd rather go with JS100 for the annuities. Of course, YMMV.
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Kevin M
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Re: Why not use inflation-adjusted SPIA?

Post by Kevin M »

Thanks for your thoughts on this Johno.

I think if I were on the borderline, I would seriously consider annuities. I think it might be hard to decide at what age to start buying them, and whether to go with nominal or inflation-adjusted.

With enough assets, I don't think it's at all unreasonable to ignore them. In other words, if one has enough assets to create an LMP with some combination of TIPS, CDs, bond funds, social security benefits, pension income, rental income, etc., that allows one to live in the manner they desire, why consider annuities?

And yes, I would like to see my children also benefiting from my portfolio if possible. We were provided opportunities by my (deceased) wife's parents that were a big part of why I was able to build a nice retirement portfolio. I'd like to do the same for my kids in some way if possible.

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Re: Why not use inflation-adjusted SPIA?

Post by toto238 »

I understand the desire to leave something for one's children or other charities or anything like that. But what I don't agree with is pooling assets saved for this purpose with assets saved for other purposes.

I would rather separate out my assets into different pools.

One pool provides for me and my needs at basic minimum acceptable lifestyle.

One pool provides for any luxuries I may want above that basic minimum acceptable lifestyle.

One pool provides security as an emergency fund as a place to obtain quick liquid assets just in case.

One pool provides my children/heirs with an inheritance.

One pool provides charities that I care about with donations.

I don't want to pool everything together into one big lump sum. Each pool has a different purpose, many have different time frames and different levels of risk appropriate for them.

But for that pool that provides for me and my needs at basic minimum acceptable lifestyle, it seems to me that an I-SPIA is the safest way to do that.
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Kevin M
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Re: Why not use inflation-adjusted SPIA?

Post by Kevin M »

^Fine if you want to do it that way, but if one's pool is large enough, there's really no need to do that mental accounting, and there's no need to pay an insurance company to hedge longevity risk. One can simply self insure.

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toto238
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Re: Why not use inflation-adjusted SPIA?

Post by toto238 »

Kevin M wrote:^Fine if you want to do it that way, but if one's pool is large enough, there's really no need to do that mental accounting, and there's no need to pay an insurance company to hedge longevity risk. One can simply self insure.

Kevin
By self-insuring, you are risking having to give up one of the other goals in case things go south.

I think it's a question of giving up the opportunity to see an even bigger number in your net worth calculation in exchange for actually winning the game.

Using a regular SPIA you still run the risk of inflation-risk, so it makes sense to self-insure.

But if you can eliminate inflation-risk, eliminate market-risk, and guarantee yourself your minimum income for the rest of your life, what's stopping you?
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Re: Why not use inflation-adjusted SPIA?

Post by Aptenodytes »

Kevin M wrote:^Fine if you want to do it that way, but if one's pool is large enough, there's really no need to do that mental accounting, and there's no need to pay an insurance company to hedge longevity risk. One can simply self insure.

Kevin
Self-insuring against longevity risk means reducing your spending below what would be viable for an average span so that you can sustain it over a very long life span. In other words, it isn't free -- you pay a very real cost in the form of reduced consumption. It isn't just "mental accounting" -- these are real dollars at play.

In other words, it is misleading to say that self-insuring is better than a SPIA because it has no cost. They both have costs and you have to weight the particular costs and benefits to choose a mix that works for you. No free lunches here.
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Re: Why not use inflation-adjusted SPIA?

Post by nisiprius »

Kevin M wrote:^Fine if you want to do it that way, but if one's pool is large enough, there's really no need to do that mental accounting, and there's no need to pay an insurance company to hedge longevity risk. One can simply self insure.

Kevin
Darn it, Kevin, there is no such thing as one individual person "self-insuring." All that one person can do is "accept the risk."

To say "I am not buying insurance because I think I can afford to take the risk myself" is a sensible thing to say. To say "Oh, I am 'insured,' I am 'self-insured'" is facile and probably self-deceptive.

When a company with 1000 employees decides that they can work the law of averages as well as any insurance company, and instead of buying some kind of insurance they just set aside enough money and pay claims themselves, that's "self-insurance." It is still pooling risk.

A pool of one person is not a pool.
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Re: Why not use inflation-adjusted SPIA?

Post by bertilak »

About dealing with inflation risk of annuities...

When I was considering the need for an SPIA, and whether or not to pay for inflation indexing, I was leaning towards buying a nominal SPIA, but relying on the size of my portfolio to allow me to buy subsequent nominal SPIA(s) to make up the difference if and when inflation overran the income from the original SPIA.

My thinking was that income from a nominal SPIA was higher so in the long run I would be getting more for my money. Adding to that, delaying purchase gets better deals as one ages -- more mortality credit. This all depends on having a large enough nest egg. Perhaps if that condition is met, then the whole idea of an SPIA, or the inflation indexing, is moot.

I decided I didn't need an SPIA so didn't follow through on that idea. I present it here just as something to consider -- more of a tactic than a strategy. Perhaps others have thought this through more thoroughly. I think I have heard the idea called "laddered SPIAs."
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Kevin M
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Re: Why not use inflation-adjusted SPIA?

Post by Kevin M »

OK, so change the wording. I thought it was common terminology. A quick Google tells me that I'm using the term in an acceptable manner: Self-insure Definition | Investopedia. I don't really care whether we call it self-insuring or being able to afford the risk without paying for insurance; you know what I'm talking about, and there is no self deception here.

So now the argument seems to be shifting from why some people should seriously consider annuities, which I agree with, to everyone should use them. Poppycock! Can you imagine Bill Gates or Warren Buffet buying an SPIA (I'm talking about for their personal spending of course)? I think not. So where do you draw the line.

I don't pay for insurance that I can afford not to have. Well, I probably pay for a bit more than I can afford not to have, but I try not to. I don't buy extended term warranties. I don't have collision insurance for low-value vehicles (but this is an area that I do pay for more insurance than I really need--it's pretty cheap). I insure my house for as little as possible, since most of the value is in the land.

I don't have specific goals for bequests. My view is that the kids get what's left over when I/we die, which I expect will be a sizable sum, but if things go horribly wrong, it might be a smaller sum. If I were investing with bequests in mind, I probably would have a riskier portfolio, but my lower willingness and need to take (market) risk take precedence over my higher ability to take risk.

If we define longevity risk as the possibility that one may run out of money before running out of life, I just don't see that in the cards. I could put 100% of my portfolio into safe assets and have essentially 0% chance of that happening. I probably could put 50% of my portfolio into safe assets, and along with delaying SS until age 70, same thing. So the 30% of portfolio in stocks probably, but not certainly, is mostly there for the kids. Maybe with enough advances in medical technology, I'll actually end up benefiting from it directly.

There also are tax considerations. The last thing I want now is more taxable income, and my understanding is that a portion of the annuity payout would be taxable. RMDs are something that I do not look forward to. I'm thinking about doing specific things later this year, that will increase my portfolio risk somewhat, to lower my taxable income next year (see my Kiddie Tax thread as to why).

And I can't imagine a scenario in which I'll actually rely on social security retirement benefits (at most, eight years in the future) to fund expenses. So that's all the longevity insurance I can imagine needing.

Maybe those could be considered indicators of whether or not you are on one side of the line or the other in terms of whether or not annuities make sense.

Again, things could go horribly, horribly wrong (in a financial sense), and I could change my mind. Hopefully the required financial devastation wouldn't be so quick that I couldn't change my mind in time.

I could see taking a different point of view though, but only up to a certain point in terms of wealth, beyond which, I still doubt annuities make any sense. For someone who does have specific bequest goals, I guess I could see buying an annuity so one could simply manage the remaining portfolio with the bequest goals in mind. But what would you invest it in? Stocks are risky, so you may not meet a specific bequest target that way, and I'd be disinclined to invest only in safe assets for a time-frame of 20+ years.

No, I come back to what I'm doing as making the most sense for me at this time. No annuities for me.

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Re: Why not use inflation-adjusted SPIA?

Post by Kevin M »

I think Jim Otar describes this in terms of zones. If you are in the red or yellow zone, an annuity or something similar probably makes sense. If you are in the green zone, there is no need. Haven't looked at his book in a long time, so maybe someone can provide more details or correct me if I'm wrong.

Kevin
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Re: Why not use inflation-adjusted SPIA?

Post by alex_686 »

dhodson wrote:Can someone point me to the evidence that insurance companies use TIPS for SPIAs to any large extent?
If you were building an insurance portfolio this is not the way that you would do it.

You would build your actuarial models. You would use TIPS for the long term real required rate of return for the portfolio. You would then add a cushion. You launch the product, sell the annuity, and bring in cash for the portfolio.

You would then buy high quality long term government and corporate bonds. Why? Because you are practicing "portfolio immunization". TIPS are for the risk adverse and the price shows it. Historically 10 year government bonds have outperformed 10 year TIPS. The point from the insurance company is to squeeze a few extra bps over the required return as safely as possible. It is not so much maximizing return but minimizing downside risk. If the fund every suffered a big loss the portfolio – enough to eat away at the cushion, only then would the portfolio switch to buying TIPS.
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Re: Why not use inflation-adjusted SPIA?

Post by Independent »

alex_686 wrote:
dhodson wrote:Can someone point me to the evidence that insurance companies use TIPS for SPIAs to any large extent?
If you were building an insurance portfolio this is not the way that you would do it.

You would build your actuarial models. You would use TIPS for the long term real required rate of return for the portfolio. You would then add a cushion. You launch the product, sell the annuity, and bring in cash for the portfolio.

You would then buy high quality long term government and corporate bonds. Why? Because you are practicing "portfolio immunization". TIPS are for the risk adverse and the price shows it. Historically 10 year government bonds have outperformed 10 year TIPS. The point from the insurance company is to squeeze a few extra bps over the required return as safely as possible. It is not so much maximizing return but minimizing downside risk. If the fund every suffered a big loss the portfolio – enough to eat away at the cushion, only then would the portfolio switch to buying TIPS.
The first business of an insurance company is to stay in business. Even if current management doesn't believe this, regulators do. They can't "immunize" a CPI-indexed liability with a fixed rate asset. Regulators and management are going to ask what happens to your bottom line the next time we see double digit inflation.

If all that mattered was long term average returns, life insurance companies would be deep into stocks. They need to report earnings and net worth every quarter, so they give up alpha to get a better asset/liability match.

(But, as I said above, AFAIK this is all theoretical. Nobody is selling enough CPI-indexed products to move any financial dials.)
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Re: Why not use inflation-adjusted SPIA?

Post by alex_686 »

Independent wrote:They can't "immunize" a CPI-indexed liability with a fixed rate asset. Regulators and management are going to ask what happens to your bottom line the next time we see double digit inflation.
TIPS is a perfect expensive hedge for inflation. However, there are other, cheaper, adequate hedges out there. Inverse floats and swaps come to mind. The conversations with the state regulates is very thorough and common, I assure you.
Independent wrote:If all that mattered was long term average returns, life insurance companies would be deep into stocks.


I think you missed my point. With "portfolio immunization" you must always have sufficient assets to cover your liabilities with safe assets, normally government bonds. Minimize downside risk.


[/quote]They need to report earnings and net worth every quarter, so they give up alpha to get a better asset/liability match.[/quote]

This is 1/2 true. You need a good asset / liability match to make the regulators happy and to make sure your company does not blow up. You want Alpha because that is your profit. If you can increase the required asset / liability spread by just 0.2% you are considered a rock star.

FYI, this is not all that theoretical. The CPI molding is robust.
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Re: Why not use inflation-adjusted SPIA?

Post by itstoomuch »

Does I-SPIA qualify as a deferred longevity annuity that now enjoy special IRS income treatment? :arrow:
[as seen on NYT business, special retirement issue, at my father's (95) house today]
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Re: Why not use inflation-adjusted SPIA?

Post by toto238 »

itstoomuch wrote:Does I-SPIA qualify as a deferred longevity annuity that now enjoy special IRS income treatment? :arrow:
[as seen on NYT business, special retirement issue, at my father's (95) house today]
This is a good point. Can someone elaborate on how SPIAs and I-SPIAs are treated taxwise? Does it matter whether they are in a Roth, a Traditional, or in a taxable account?

And people have been talking about Medicaid eligibility. If you're not anticipating ever being low-income enough to qualify for Medicaid, why would that matter?

What am I missing here?
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Re: Why not use inflation-adjusted SPIA?

Post by dhodson »

alex_686 wrote:
dhodson wrote:Can someone point me to the evidence that insurance companies use TIPS for SPIAs to any large extent?
If you were building an insurance portfolio this is not the way that you would do it.

You would build your actuarial models. You would use TIPS for the long term real required rate of return for the portfolio. You would then add a cushion. You launch the product, sell the annuity, and bring in cash for the portfolio.

You would then buy high quality long term government and corporate bonds. Why? Because you are practicing "portfolio immunization". TIPS are for the risk adverse and the price shows it. Historically 10 year government bonds have outperformed 10 year TIPS. The point from the insurance company is to squeeze a few extra bps over the required return as safely as possible. It is not so much maximizing return but minimizing downside risk. If the fund every suffered a big loss the portfolio – enough to eat away at the cushion, only then would the portfolio switch to buying TIPS.
Thats sort of what im getting at. I dont think they are using TIPS to the extent mentioned by some but this is just my opinion. I would also differ though on thoughts of what the insurance company is trying to do. The management, just like every other company, is trying to squeeze out as much as possible since in reality their job security is more about the short term. Even if they are a mutual company, they get reviewed based on relatively short term results. Its just regulators are going to require some sort of "proof" and "safety" that their model will hold in order to allow them to sell the product. As can be seen with LTCi, that proof isnt always reliable.
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Re: Why not use inflation-adjusted SPIA?

Post by itstoomuch »

alex_686 wrote:TIPS is a perfect expensive hedge for inflation. However, there are other, cheaper, adequate hedges out there. Inverse floats and swaps come to mind. The conversations with the state regulates is very thorough and common, I assure you.
Two things I learned by the fall of 2008.
1. If you have your entire retirement wealth tied up in MFs, regardless of allocation. You own whatever risk that presents itself.
2.Hubris is dangerous. My older bro at big bank, essentially said, "Don't worry, be happy. We know what we are doing and are well protected."
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Re: Why not use inflation-adjusted SPIA?

Post by Kevin M »

I actually did a quick Google on taxation of SPIAs before my last post. What I read was that if purchased with after-tax dollars, the principle is allocated across the payments, and the return of principal portion is not taxed, which makes sense. I'd assume that if purchased with pre-tax dollars, all payments would be taxed.

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Re: Why not use inflation-adjusted SPIA?

Post by toto238 »

Kevin M wrote:I actually did a quick Google on taxation of SPIAs before my last post. What I read was that if purchased with after-tax dollars, the principle is allocated across the payments, and the return of principal portion is not taxed, which makes sense. I'd assume that if purchased with pre-tax dollars, all payments would be taxed.

Kevin

And I'd imagine for a Roth the entirety would be tax-free.

But then why are people super concerned about how that works tax-wise? and what are they mentioning about Medicaid? Is there an estate planning concept i'm missing here?
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Re: Why not use inflation-adjusted SPIA?

Post by Kevin M »

toto238 wrote: But then why are people super concerned about how that works tax-wise? and what are they mentioning about Medicaid? Is there an estate planning concept i'm missing here?
I don't know about others, but as I mentioned already, I do not want any more taxable income, and can't foresee wanting any more than I already have in future years. Yet I will not have a choice when RMDs start, and that will be compounded by social security retirement benefits. I don't have enough in Roths for that to be a significant factor.

Regarding Medicaid, the article linked earlier, Using Annuities in Medicaid Long-Term Care Planning | Nolo.com, actually points out how buying an immediate annuity can be used to deplete the assets of a couple so one spouse can qualify for Medicaid, while having the annuity provide an income stream for the other spouse. So it's a plus for SPIAs if done properly.

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Re: Why not use inflation-adjusted SPIA?

Post by randomguy »

bertilak wrote:About dealing with inflation risk of annuities...

When I was considering the need for an SPIA, and whether or not to pay for inflation indexing, I was leaning towards buying a nominal SPIA, but relying on the size of my portfolio to allow me to buy subsequent nominal SPIA(s) to make up the difference if and when inflation overran the income from the original SPIA.

My thinking was that income from a nominal SPIA was higher so in the long run I would be getting more for my money. Adding to that, delaying purchase gets better deals as one ages -- more mortality credit. This all depends on having a large enough nest egg. Perhaps if that condition is met, then the whole idea of an SPIA, or the inflation indexing, is moot.

I decided I didn't need an SPIA so didn't follow through on that idea. I present it here just as something to consider -- more of a tactic than a strategy. Perhaps others have thought this through more thoroughly. I think I have heard the idea called "laddered SPIAs."
In normal inflation (call it <4%) schemes like this work fine. If we hit something like 10% inflation for a decade, you will find the original SPIA gets eroded quickly and your other assets might not be worth enough to purchase replacements (see the 70s). How big that risk is and if you want to worry about is up to you.
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Re: Why not use inflation-adjusted SPIA?

Post by nedsaid »

itstoomuch wrote:Gosh, Nesaid, I imagined you to be much older. :oops:
Wow. I am both very old and very rich. Didn't know that. :D :D :D
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Re: Why not use inflation-adjusted SPIA?

Post by Kevin M »

randomguy wrote: In normal inflation (call it <4%) schemes like this work fine. If we hit something like 10% inflation for a decade, you will find the original SPIA gets eroded quickly and your other assets might not be worth enough to purchase replacements (see the 70s). How big that risk is and if you want to worry about is up to you.
Good point. But TIPS didn't exist in the 70s; they do now. So perhaps a combination of nominal SPIAs, purchased over time at different companies, and TIPS might make some sense. This also lessens the systemic risk and company-specific risk of insurance companies.

Absent very sudden, large unexpected inflation, short term nominal bonds (or CDs with low early withdrawal penalties) provide pretty good inflation protection, since interest rates tend to rise and fall with inflation. I'm sticking with CDs for now, assuming that there will be enough warning signs to move more into TIPS in time to keep from being devastated by really high inflation.

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Re: Why not use inflation-adjusted SPIA?

Post by bertilak »

randomguy wrote:In normal inflation (call it <4%) schemes like this work fine. If we hit something like 10% inflation for a decade, you will find the original SPIA gets eroded quickly and your other assets might not be worth enough to purchase replacements (see the 70s). How big that risk is and if you want to worry about is up to you.
The saving grace is that the money you are sitting on as inflation eats away at your SPIA should provide some hedge against that inflation if it is wisely invested. But you are right -- an inflation indexed SPIA unloads risk in a way you can't do on your own.
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Re: Why not use inflation-adjusted SPIA?

Post by RetiredinKaty »

toto238 wrote:
And I'd imagine for a Roth the entirety would be tax-free.
Someone please correct this if I am wrong. But I think the way it works is you have to withdraw money from the Roth, making it ordinary after tax non-qualified money, then buy an annuity. So the interest portion of the annuity payments would be taxable.
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Re: Why not use inflation-adjusted SPIA?

Post by DG99999 »

Great discussion in this thread.

Couple of ancillary/tangential points with regard to comments above:

1. I believe the insurers are required by regulation/law not to use the State Guaranty Association(s) in their sale of annuity products. This may be part of the reason the SGAs are not very well understood. (I would think the insurers would like to present them as a sales point).

2. One point to remember about SWR is that theoretically it can be reset/restarted at any time. So, for example, on a $1,000,000 portfolio you take an income of $40k in year #1 and are slated to take $41,200 in year #2. But if your portfolio has grown to $1,100,000 at the end of year #1, then there is nothing stopping you from restarting the SWR calculation at a withdrawal of $44k with a new 30 year period (or even slightly more with a 29 year period). Of course, you can carry out this logic to a much later year in the period after a market run-up using the anticipated life expectancy to calculate a new starting rate which may be greater than the original rate plus inflation. This is not to criticize or dissuade from IA-SPIAs or SPIAs, as I favor and anticipate using them, but I have seen critiques about SWR mindlessly locking one in to a 30 year formula and that is not necessarily true.

EDIT: I see plannerman also mentions point #2, above.

3. One could consider if annuities offer a certain sort of "protection" in the event of cognitive issues which might open you up to either theft of your assets or poor decisions resulting in poor portfolio performance.

4. I saw one post, elsewhere, that suggested annuities might functionally "preserve" more assets for a healthy spouse if the partner required significant long term care, then subsequently passed away. Not certain of all the details and legalities around this assertion.
Last edited by DG99999 on Fri Mar 13, 2015 2:09 am, edited 2 times in total.
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Re: Why not use inflation-adjusted SPIA?

Post by DG99999 »

nedsaid wrote:
itstoomuch wrote:Gosh, Nesaid, I imagined you to be much older. :oops:
Wow. I am both very old and very rich. Didn't know that. :D :D :D
Well we first saw you in 1947 as a youngster, and don't try to say all those comic strips didn't make you a boatload of money!

:happy
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Re: Why not use inflation-adjusted SPIA?

Post by DG99999 »

RetiredinKaty wrote:
toto238 wrote:
And I'd imagine for a Roth the entirety would be tax-free.
Someone please correct this if I am wrong. But I think the way it works is you have to withdraw money from the Roth, making it ordinary after tax non-qualified money, then buy an annuity. So the interest portion of the annuity payments would be taxable.
That is my understanding as well.
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Re: Why not use inflation-adjusted SPIA?

Post by dodecahedron »

DG99999 wrote:
RetiredinKaty wrote:
toto238 wrote:
And I'd imagine for a Roth the entirety would be tax-free.
Someone please correct this if I am wrong. But I think the way it works is you have to withdraw money from the Roth, making it ordinary after tax non-qualified money, then buy an annuity. So the interest portion of the annuity payments would be taxable.
That is my understanding as well.
I do not believe this is always the case. I have a Roth 403b as well as a Roth IRA at TIAA-CREF. If I choose to annuitize some or all of the funds in my Roth accounts, the annuity payments would be tax free distributions to me, in other words, I have the option to annuitize within the tax free account and receive a tax free stream of payments over my lifetime. I do not have to take distributions and then use the proceeds to purchase an annuity making taxable payments.

To connect this to the overall topic of this thread, TIAA-CREF does have a variable annuity account that invests in inflation-linked bonds. This would seem to be one way to purchase an inflation-linked annuity, though the vicissitudes of swings in real interest rates and the AIR computations would mean the correlation to annual inflation would be imperfect.
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Re: Why not use inflation-adjusted SPIA?

Post by skepticalobserver »

Is it a good idea to irrevocably gift $727k ?

As you probably know commercially available SPIAs are structured to generate positive IRR only many years into the contract, and that for most of the life of the contract you’re pretty much getting your own money back (the reason annuities are touted as “tax advantaged”).

Insuring against running out of money is best done by husbanding financial resources: cost control and self-annuitization. Inflation will be reflected in a reliable shorter term fixed income portfolio: t-bills, highly rated commercial paper or t-notes under 3 years.
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Re: Why not use inflation-adjusted SPIA?

Post by bertilak »

About IRAs, RMDs, etc... I found this: http://whitecoatinvestor.com/individual ... d-dilemma/

Read the whole thing, but scroll down to "Individual Retirement Annuity" for a nice summary. It lists three different ways one can mix and match IRAs and SPIAs and the effects on RMDs. All those possibilities can be confusing, especially if someone is only familiar with one or two of them.
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Re: Why not use inflation-adjusted SPIA?

Post by dodecahedron »

The WCI article bertilak linked is helpful but it does not specifically address the question of an annuity purchased with Roth IRA funds (except in a brief remark in the comments). Here is a WSJ article discussing that particular issue:

http://www.wsj.com/articles/SB123940116579609529
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