Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

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Bill Bernstein
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by Bill Bernstein »

But in the real world why would we be sitting with 30x expenses in investments with 0 duration?
That implies that you're committing all of your nest egg to TIPS. As both sides of this thread have noted, no one does this. Further, it doesn't make a lot of sense to purchase TIPS until you're within 5-10 years of retirement. (Those of us who are on the wrong side of 70, BTW, don't have to worry too much about the TIPS/longevity problem.)

But for most of the past 10 years there's been little reward for going out the yield curve. As I pointed out in the piece, last year you got all of 13 extra bp for going out from 3 months to 5 years; as I also wrote, that wasn't yield curve, it was an IQ test.

So the rational investor kept most of their fixed income short, a large dollop of which just went, a la Allan and #cruncher, into TIPS.

As another frequent poster on this thread might say, quite a nice "whatever price."
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by GreenLawn »

vineviz wrote: Sun Dec 04, 2022 11:23 am
...But by the same logic the decision to NOT buy an income annuity is a "bet" that you will die when expected, or sooner.

So then the question becomes whether it is better to put all your money on one of those bets, or to diversify between those bets.
That's assuming an annuity must be purchased if I don't know my expiration date. A non-COLA annuity is just an expensive bet that inflation will stay low, a bet I won't take, and hence is not an option for me.

I thought the whole point of an annuity is to provide a rock solid source of funding in retirement, allowing me to take risk in other areas such as equities. But if there is no inflation adjustment, it's not rock solid at all, and in fact I'd argue will fare worse in an inflationary environment than VTI would.

I understand why annuities are so popular. Take away the inflation risk and they become quite attractive. But the insurance industry wants to offload the inflation risk onto purchasers, and I won't accept that.

Social Security will be my annuity when I take it at age 70. Adding to that will be a variety of investments, including TIPS, I-bonds, and equities.
So I will have plenty of diversification.

I will have an annuity and diversification, what more can you ask for? :happy
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by vineviz »

GreenLawn wrote: Sun Dec 04, 2022 4:39 pm
vineviz wrote: Sun Dec 04, 2022 11:23 am
...But by the same logic the decision to NOT buy an income annuity is a "bet" that you will die when expected, or sooner.

So then the question becomes whether it is better to put all your money on one of those bets, or to diversify between those bets.
That's assuming an annuity must be purchased if I don't know my expiration date. A non-COLA annuity is just an expensive bet that inflation will stay low, a bet I won't take, and hence is not an option for me.
You misunderstand the nature of this tool.

An income annuity is not "just an expensive bet that inflation will stay low": it is more than that, and mitigates some risks that there are literally no other ways to mitigate.

In any case, it is no MORE of a bet on inflation than nominal bonds are. For some reason, those don't seem as scary to people.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by GAAP »

vineviz wrote: Sun Dec 04, 2022 4:50 pm In any case, it is no MORE of a bet on inflation than nominal bonds are. For some reason, those don't seem as scary to people.
My guess is that most people aren't buying individual corporate bonds. Those would be a much closer comparison to me than a nominal bond fund. Individual bonds and annuities are both corporate issuers and a single-source risk. Bond funds are different animals entirely -- especially those that invest in the total market. Yes, the corporate bond would have fixed maturity, so it's not an exact comparison -- but I still think it's a better comparison.

I would be curious to see how many of those that are uncomfortable with annuities are buying nominal bond funds, and vice-versa. For the record, I'm not convinced about annuities, and gave up on individual bonds a long time ago.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by Blue456 »

NiceUnparticularMan wrote: Sun Dec 04, 2022 10:44 am
Blue456 wrote: Sun Dec 04, 2022 5:34 am Equities have historically kept up with inflation over longer duration of time
That has not always been true in all times and places, and is particularly less likely to be true in a given period if stock pricing has gotten historically high such that expected real stock returns have gotten historically low.
For anybody who is US only in equity. For those of us who are diversified in international markets this is not an issue.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by vineviz »

GAAP wrote: Sun Dec 04, 2022 5:05 pm I would be curious to see how many of those that are uncomfortable with annuities are buying nominal bond funds, and vice-versa. For the record, I'm not convinced about annuities, and gave up on individual bonds a long time ago.
Among the 250 largest taxable bond mutual funds, 236 are nominal bond funds. They contain 96.7% of all the taxable bond assets.

I don't think there's any doubt that a lot more people are buying nominal bonds than are buying nominal SPIAs.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by GreenLawn »

vineviz wrote: Sun Dec 04, 2022 4:50 pm
GreenLawn wrote: Sun Dec 04, 2022 4:39 pm
vineviz wrote: Sun Dec 04, 2022 11:23 am
...But by the same logic the decision to NOT buy an income annuity is a "bet" that you will die when expected, or sooner.

So then the question becomes whether it is better to put all your money on one of those bets, or to diversify between those bets.
That's assuming an annuity must be purchased if I don't know my expiration date. A non-COLA annuity is just an expensive bet that inflation will stay low, a bet I won't take, and hence is not an option for me.
You misunderstand the nature of this tool.

An income annuity is not "just an expensive bet that inflation will stay low": it is more than that, and mitigates some risks that there are literally no other ways to mitigate.

In any case, it is no MORE of a bet on inflation than nominal bonds are. For some reason, those don't seem as scary to people.
Because nominal bonds can be sold. A bad bet on a bond is unfortunate, but can easily be rectified with a couple of mouse clicks. A bad bet on an annuity lasts a lifetime.

But in any case, I think our respective positions are clear at this point. I'm all about inflation risk when it comes to annuities. For others that's a secondary concern.

Fair enough, I'm fine with alternative perspectives. Plenty of folks buy annuities, they are voting for your perspective with their dollars. If we were to take a poll, I'd have to say you'd win :sharebeer
Last edited by GreenLawn on Sun Dec 04, 2022 5:52 pm, edited 1 time in total.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by Svensk Anga »

vineviz wrote: Sun Dec 04, 2022 5:33 pm
GAAP wrote: Sun Dec 04, 2022 5:05 pm I would be curious to see how many of those that are uncomfortable with annuities are buying nominal bond funds, and vice-versa. For the record, I'm not convinced about annuities, and gave up on individual bonds a long time ago.
Among the 250 largest taxable bond mutual funds, 236 are nominal bond funds. They contain 96.7% of all the taxable bond assets.

I don't think there's any doubt that a lot more people are buying nominal bonds than are buying nominal SPIAs.
sure, but how many are buying nominal bonds in durations similar to SPIAs? One would have to be pretty old for Total Bond Market to have duration similar to an annuity.

True, a year or more ago there was some noise on Bogleheads about folks buying long Treasuries thinking they were guaranteed negative correlation with stocks. I think the last year has shelved that idea.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by Bill Bernstein »

True, a year or more ago there was some noise on Bogleheads about folks buying long Treasuries thinking they were guaranteed negative correlation with stocks. I think the last year has shelved that idea.
There's a memorable line in Ed Chancellor's The Price of Time about how last year bonds had gotten so ridiculously overpriced that folks bought stocks for income and bonds for capital gains (in anticipation of negative yields in the US, and more negative yields in Europe).

But I suppose there are some who would say that since millions of investors happily bought bonds with zero or negative yields, it must have been a good idea.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by vineviz »

GreenLawn wrote: Sun Dec 04, 2022 5:50 pm
Because nominal bonds can be sold. A bad bet on a bond is unfortunate, but can easily be rectified with a couple of mouse clicks. A bad bet on an annuity lasts a lifetime.
This statement clearly reflects a misunderstanding about the nature of bonds and their behavior, especially with regard to retirement planning.

Unexpectedly high inflation is a problem for ALL nominal income streams, and there is no "rectifying" that fact with mouse clicks or any other trickery: it's simply the nature of the beast.

The error is in thinking that inflation affects nominal SPIAs differently to nominal bonds.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by vineviz »

Svensk Anga wrote: Sun Dec 04, 2022 5:52 pm sure, but how many are buying nominal bonds in durations similar to SPIAs? One would have to be pretty old for Total Bond Market to have duration similar to an annuity.
I'm not sure why you're asking. The duration of the nominal bonds isn't relevant to the inflation risk.

Besides the fact that many retirees are happily ADDING on real interest rate risk by choosing short duration bonds only magnifies the case that bonds are held to a clearly different standard than SPIAs.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by Northern Flicker »

Bill Bernstein wrote: Sun Dec 04, 2022 12:29 pm
self-insuring against longevity is perhaps more costly than some tend to acknowledge.
Top
This is undoubtedly true to the extent that the issuing company isn't pocketing the lion's share of the true actuarial mortality credit.

But you get what you pay for: self-insured TIPS-based longevity insurance pays off in real dollars, a SPIA's sure doesn't.

Bill
What is TIPS-based longevity insurance? Is it funding out to age 105? Suppose a couple starts collecting SS at age 70, and suppose SS covers 1/2 of their expenses. They can fund 35 years of that with TIPS or about 15 years of it with a SPIA. As these numbers are estimates, let's say the TIPS portfolio/ladder costs about 2x the cost of the SPIA because the TIPS must fund more years and the SPIA has no COLA.

Instead of funding the TIPS portfolio, the retiree could hold something like:

50% nominal SPIA
50% stock or 30% stock + 20% TIPS

The retiree who puts everything in TIPS has covered liabilities and inflation, but is seriously exposed to unpredictable expenses such as uninsured long-term care as one possible example.

The retiree with SPIA, stocks, and TIPS has wrapped inflation for the expenses not covered by SS (half of liabilities in the example) in with other unpredictable expenses to be covered by stock or stock and TIPS.

The all-TIPS solution is a kind of financial Maginot Line. Inflation is addressed at all cost, but there is no mechanism to address expenses turning out to be significantly higher than projected for reasons other than inflation. It also is exposed to the retiree's inflation rate differing from the corrections for TIPS (CPI-U) and SS (CPI-W). For instance, we have seen health care and long-term care costs grow much faster than CPI-U/W at times.

A hybrid approach is also possible: hold the asset to be annuitized as TIPS, and annuitize at a later date to reduce the number years the asset is exposed to inflation.

A portfolio of rolling commodities futures like VCMDX also can cover inflation risk for more than just itself.

But any analysis needs to look at all the full picture, and not just compare two asset classes (TIPS and SPIA) in a vacuum.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by Northern Flicker »

Svensk Anga wrote: Sun Dec 04, 2022 5:52 pm
vineviz wrote: Sun Dec 04, 2022 5:33 pm
GAAP wrote: Sun Dec 04, 2022 5:05 pm I would be curious to see how many of those that are uncomfortable with annuities are buying nominal bond funds, and vice-versa. For the record, I'm not convinced about annuities, and gave up on individual bonds a long time ago.
Among the 250 largest taxable bond mutual funds, 236 are nominal bond funds. They contain 96.7% of all the taxable bond assets.

I don't think there's any doubt that a lot more people are buying nominal bonds than are buying nominal SPIAs.
sure, but how many are buying nominal bonds in durations similar to SPIAs? One would have to be pretty old for Total Bond Market to have duration similar to an annuity.
An annuitant who buys a SPIA with 15 years to go until the age of life expectancy is buying an instrument with about an 8 year expected duration at the time of purchase.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by abc132 »

Bill Bernstein wrote: Sun Dec 04, 2022 2:26 pm
But in the real world why would we be sitting with 30x expenses in investments with 0 duration?
That implies that you're committing all of your nest egg to TIPS. As both sides of this thread have noted, no one does this. Further, it doesn't make a lot of sense to purchase TIPS until you're within 5-10 years of retirement. (Those of us who are on the wrong side of 70, BTW, don't have to worry too much about the TIPS/longevity problem.)
Agreed, and yet this is what your analysis assumes when getting the current rates for all 30 years. You should have taken 3 years of TIPS each purchased for the last 10 years as your comparison in the article. Even if you are avoiding purchases at -1%, you are suggesting that 0% real and even 1% real is a bad time to buy TIPS. Why would one have waited will all their money for close to 2% real? It is like saying today is a better time to buy stocks with guaranteed 20% higher returns than a year ago. That is useless information as there was no reasonable guarantee of the current price. TIPS should have been bought at 0-1% real based on low 1/CAPE expected returns.
Bill Bernstein wrote: Sun Dec 04, 2022 2:26 pm But for most of the past 10 years there's been little reward for going out the yield curve. As I pointed out in the piece, last year you got all of 13 extra bp for going out from 3 months to 5 years; as I also wrote, that wasn't yield curve, it was an IQ test.

So the rational investor kept most of their fixed income short, a large dollop of which just went, a la Allan and #cruncher, into TIPS.

As another frequent poster on this thread might say, quite a nice "whatever price."
According to Portfolio Visualizer, someone who stayed in short term treasuries for the past 10 years (Nov 2012 to Nov 2022) lost out to intermediate treasuries. You may have done better in 2022 but you did much worse in 2019, 2020, and 2021.

Can you explain the reasons why someone would have chosen longer duration for 9 years and then suddenly shortened duration in 2021 when by your own words the reasoning for shortened duration existed for 10 years? This IQ test seems very flawed based on the 10-year results. TIPS funds have done better than short or intermediate over the last 10 years. You could have invested in TIPS, sold them for short term, and bought even more new TIPS with the money gained. Why was waiting for TIPS a good choice if it lost money relative to all other options (purchasing them earlier or investing in intermediate nominals)?

The only conclusion I see is that new money should be going into TIPS. Holding money in cash/short for a decade waiting for better pay-off for duration seems to have been a losing move as does not purchasing TIPS funds earlier. I think we agree one should purchase the TIPS ladder over 5-10 years but I'm curious why your analysis does not reflect that. It leads to different assumptions for the two things being compared which is fatal to the conclusions.

Option A
If the TIPS ladder has 5-10 years to lock in 1.6% real, the annuity also has to have 5-10 years in which excess money can be locked in with 10-15 year duration at 1.6% real. Giving the TIPS ladder 5-10 years at the current rate and the annuity 0 years to for excess money to earn the current rate is grossly unfair.

Option B
The best comparison is a TIPS ladder purchased over the last 10 years (3 years expenses per year) with an annuity purchased in 3 stages over the last 10 years. Looking at where people choosing each option would actually be sitting is the fairest comparison.
Last edited by abc132 on Mon Dec 05, 2022 1:35 am, edited 3 times in total.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by Marseille07 »

Lawrence of Suburbia wrote: Sat Dec 03, 2022 11:33 pm I'm actually happy with my SPIA (so far). I guess I'm trying to see how much things like TIPS are going to become Boglehead canon like the 3-fund portfolio.
My point is that if you didn't buy the SPIA and kept the 60K instead, you'd be drawing 2.4K/year from the 60K. That's less than half of your 5K income stream. SPIA sounds like a better move even though it isn't COLA'ed.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by abc132 »

Bill Bernstein wrote: Sun Dec 04, 2022 1:26 pm I thought pretty carefully about the real return on the "side" account.

When I wrote it, I was sure I could get a 1.6% real return on my TIPS until they matured.

I sincerely doubt that you'll get that in the future on short Treasuries, a process that may have already begun in the past week.

Bill
Your article is well-written and got me interested so I did some calculations.

The current rate from immediateannuities.com from the state I picked:
65 year male with 65 year old female secondary: 1 million buys 5884 per month
With 5.4% inflation the TIPS pays out 1.258 vs 1.067 million or +190,700 real dollars
Breakeven is 3.93% inflation where each pays out 1.258 million real dollars.
With 2.5% inflation the TIPS pays out 1.258 vs 1.425 million or -242,500 real dollars.

I think this is really a wash for anyone with an additional 20% buffer in their portfolio. It's easy enough to see that in your example we only need need 23.85x expenses to create the 30 year TIPS ladder. 1,000,000/(3474.73*12). Someone with an extra 5 years of expenses is safe from inflation whether they take the nominal annuity or the TIPS option.

Given the suggested limit of 50x expenses for self-protection at age 60, anyone with 30-50x expenses should be just fine with either a nominal annuity or a TIPS ladder. Only those with 24-28x expenses that are willing to TIPS ladder almost everything they own should be concerned about choosing TIPS over an annuity for inflation protection. If social security is 30% of income we need less than 20x expenses to be able to fund either option with a good amount of inflation protection.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by ScubaHogg »

GAAP wrote: Fri Dec 02, 2022 1:24 pm
Another way that is not frequently discussed here -- or is just unpopular -- is the use of a HECM (Reverse Mortgage) to gift home equity to beneficiaries without affecting the underlying investment portfolio.
Clever. So you’d just take the withdrawal out of the HECM and make a gift to the beneficiaries?
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by Bill Bernstein »

Someone with an extra 5 years of expenses is safe from inflation whether they take the nominal annuity or the TIPS option.
Probably true, except that the inflation protection with the "extra 20% pad" in your example with TIPS is absolute, whereas with an annuity it's relative.

I.e., the TIPS ladder is safe no matter how high inflation is, whereas with an annuity it's possible to come up with an inflation rate high enough to produce a bad result.

There's a real money illusion with annuities. Buyers are "happy" with them because of the high initial payout, and hyperbolically discount the damage done by inflation with the passage of time.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

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By the way, I bought more TIPS funds today. The discussion in this thread and in the similar thread based upon an Allan Roth article. Inflation is public enemy number one for investors.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by GAAP »

vineviz wrote: Sun Dec 04, 2022 5:33 pm
GAAP wrote: Sun Dec 04, 2022 5:05 pm I would be curious to see how many of those that are uncomfortable with annuities are buying nominal bond funds, and vice-versa. For the record, I'm not convinced about annuities, and gave up on individual bonds a long time ago.
Among the 250 largest taxable bond mutual funds, 236 are nominal bond funds. They contain 96.7% of all the taxable bond assets.

I don't think there's any doubt that a lot more people are buying nominal bonds than are buying nominal SPIAs.
Yes, they are buying bond funds, they are not generally buying individual corporate issues. The inherent diversity of a bond fund is something that does not seem to be available for annuities. People who listen even vaguely to the fund diversification mantra will have a natural bias against a single issuer nominal income stream. Very few will take the extra step to understand the differences between a bond paying $100/month for the next 30 years and an annuity paying $100/month until death -- except for the part where their heirs potentially get something from a bond while not getting something from the annuity.

Yes, that is a simplistic view -- but simplistic views are common, and likely to be the norm for the general investing public.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by VictoriaF »

Does buying $10k worth of I bonds on the annual basis count as $10k of real income 30 years later?

Counter-arguments include:
(1) Taxes will diminish this income. But the same is true for TIPS in non-Roth accounts.
(2) 0%-0.4% I bonds fixed rate is lower than the current TIPS real rates. But >1% TIPS rates are recent.

But: if the goal is to protect from a high prolonged inflation, I bonds seem as qualified as TIPS.

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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by vineviz »

GAAP wrote: Mon Dec 05, 2022 12:49 pm
vineviz wrote: Sun Dec 04, 2022 5:33 pm
GAAP wrote: Sun Dec 04, 2022 5:05 pm I would be curious to see how many of those that are uncomfortable with annuities are buying nominal bond funds, and vice-versa. For the record, I'm not convinced about annuities, and gave up on individual bonds a long time ago.
Among the 250 largest taxable bond mutual funds, 236 are nominal bond funds. They contain 96.7% of all the taxable bond assets.

I don't think there's any doubt that a lot more people are buying nominal bonds than are buying nominal SPIAs.
Yes, they are buying bond funds, they are not generally buying individual corporate issues. The inherent diversity of a bond fund is something that does not seem to be available for annuities. People who listen even vaguely to the fund diversification mantra will have a natural bias against a single issuer nominal income stream. Very few will take the extra step to understand the differences between a bond paying $100/month for the next 30 years and an annuity paying $100/month until death -- except for the part where their heirs potentially get something from a bond while not getting something from the annuity.

Yes, that is a simplistic view -- but simplistic views are common, and likely to be the norm for the general investing public.
Not only is it possible to diversify among SPIA issuers, it is a common recommendation to do so.

It is true that many investors make the same error made in the article we are discussing, which is to focus on just one part that the retirement planning problem instead of looking at the whole picture .

For instance, under a wide range of potential outcomes (including higher inflation than we have ever witnessed in the US) including a SPIA in the retirement plan will result in a larger bequest to heirs, not a smaller one.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by GAAP »

ScubaHogg wrote: Mon Dec 05, 2022 6:43 am
GAAP wrote: Fri Dec 02, 2022 1:24 pm
Another way that is not frequently discussed here -- or is just unpopular -- is the use of a HECM (Reverse Mortgage) to gift home equity to beneficiaries without affecting the underlying investment portfolio.
Clever. So you’d just take the withdrawal out of the HECM and make a gift to the beneficiaries?
Yes. They get something of value early. It reduces the value of what they get later, but increases the certainty of the value that they get.

I live in a state that has an Estate Tax which is technically indexed to inflation, but using a measure that is no longer published -- and therefore isn't actually indexed. Using a HECM for this purpose also reduces the amount of the estate valuation that is subject to the whims of the real estate market -- and harder to estimate in advance. I plan to set aside sufficient funds in taxable space to settle the estate, including the estate taxes, without my heirs having to sell the house. Tax-advantaged accounts can use a TOD transfer, and should have a higher value than if I had used them to fund early gifts.

Home equity is not liquid, HECMs provide a way to create liquidity from equity.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by bobcat2 »

VictoriaF wrote: Mon Dec 05, 2022 12:56 pm Does buying $10k worth of I bonds on the annual basis count as $10k of real income 30 years later?
Victoria
Yes! Actually for all years 5-30, since there is no interest rate risk. I tend to think of Ibonds purchased beyond age 70 as real perpetual bonds. :wink:

Happy Holidays, Victoria. :D

Best,
Bob
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by abc132 »

Bill Bernstein wrote: Mon Dec 05, 2022 12:18 pm
Someone with an extra 5 years of expenses is safe from inflation whether they take the nominal annuity or the TIPS option.
Probably true, except that the inflation protection with the "extra 20% pad" in your example with TIPS is absolute, whereas with an annuity it's relative.

I.e., the TIPS ladder is safe no matter how high inflation is, whereas with an annuity it's possible to come up with an inflation rate high enough to produce a bad result.

There's a real money illusion with annuities. Buyers are "happy" with them because of the high initial payout, and hyperbolically discount the damage done by inflation with the passage of time.
I agree if you consider the only option of holding the excess payments and portfolio in a "safe" assets. If you hold the excess in a stock/bond portfolio you have much higher expected returns. The stocks have a good decade to try and earn at least 0% real before you need the excess. You don't even need 0% real with additional portfolio size. This has a very high historical chance even when inflation is occurring. Most people are dramatically better off having some stock risk and most people take some of this risk. I would go so far to say the comparison you are making, while correct, doesn't make sense for 99.9% of investors that would consider these products.
Last edited by abc132 on Mon Dec 05, 2022 1:59 pm, edited 1 time in total.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by VictoriaF »

bobcat2 wrote: Mon Dec 05, 2022 1:28 pm
VictoriaF wrote: Mon Dec 05, 2022 12:56 pm Does buying $10k worth of I bonds on the annual basis count as $10k of real income 30 years later?
Victoria
Yes! Actually for all years 5-30, since there is no interest rate risk. I tend to think of Ibonds purchased beyond age 70 as real perpetual bonds. :wink:

Happy Holidays, Victoria. :D

Best,
Bob
Thank you, Bob,

Happy holidays to your, too,

Victoria
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by Northern Flicker »

Bill Bernstein wrote: Mon Dec 05, 2022 12:18 pm There's a real money illusion with annuities. Buyers are "happy" with them because of the high initial payout, and hyperbolically discount the damage done by inflation with the passage of time.
An allocation of 18-20% rolling commodities with a product like VMCDX packaged with 80-82% in a nominal SPIA should cover the inflation risk. Let's call it 20%. How much extra does it cost to fund the longevity exposure with TIPS?
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by David Jay »

Lawrence of Suburbia wrote: Thu Dec 01, 2022 3:07 amIsn't that kinda one of those apocalyptic worries that paralyzes someone trying to make a decision? I mean, the U.S. government could default on its bond payments; a future congress might slash or defund Social Security; WWIII might break out, with the U.S. homeland devastated; etc. etc.
You left out the mass-extinction asteroid strike.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by Bill Bernstein »

I agree if you consider the only option of holding the excess payments and portfolio in a "safe" assets. If you hold the excess in a stock/bond portfolio you have much higher expected returns. The stocks have a good decade to try and earn at least 0% real before you need the excess. You don't even need 0% real with additional portfolio size. This has a very high historical chance even when inflation is occurring. Most people are dramatically better off having some stock risk and most people take some of this risk. I would go so far to say the comparison you are making, while correct, doesn't make sense for 99.9% of investors that would consider these products.
Agree completely, I was really talking about the more general need for a longevity kicker on top of the TIPS ladder; in a world in which the 30-year return of equities doesn't beat inflation, your portfolio is the least of your problems. An equity kicker on top of TIPS ladder also gives you the optionality of converting it at some point to buying TIPS further out from the initial 30-year rung, or of directing the dividend stream into more TIPS purchases.

As the TIPS markets demonstrated in October, good things come to those who wait.

And to repeat a point made previously, if you're on the wrong side of 70, you don't need the kicker.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by Northern Flicker »

Northern Flicker wrote: Mon Dec 05, 2022 1:58 pm
Bill Bernstein wrote: Mon Dec 05, 2022 12:18 pm There's a real money illusion with annuities. Buyers are "happy" with them because of the high initial payout, and hyperbolically discount the damage done by inflation with the passage of time.
An allocation of 18-20% rolling commodities with a product like VMCDX packaged with 80-82% in a nominal SPIA should cover the inflation risk. Let's call it 20%. How much extra does it cost to fund the longevity exposure with TIPS?
Here is a comparison of intermediate TIPS with intermediate treasuries, and intermediate treasuries with inflation hedged using commodities with two different portfolios for doing that. The time period beginning coincides with the start of the recent bout of inflation.

https://www.portfoliovisualizer.com/bac ... tion3_3=15

TIPS were actually the less efficient portfolio, but that aside, the same technique can be used with a nominal SPIA. It will result in a 15-20% reduction in payout rate (15% for bonds in this backtest).

Using a TIPS ladder instead of a nominal SPIA replaces inflation risk with longevity risk if duration is held constant (funding rungs of the TIPS ladder out to the age of life expectancy). To hedge longevity risk, the TIPS portfolio has to be funded for a longer duration and/or at a higher level. How much is that?

I believe that longevity risk likely is the more expensive risk to hedge, but until that is quantified, no claim about the comparison of TIPS and a SPIA is actually even being made in any precise way.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by abc132 »

I think it is fair to say that a nominal annuity doesn't provide any longevity protection in the case of 5.4% annual inflation. The 70,608 nominal annual payment I found available today from a 1,000,000 purchase ends up with a budget short of 190k as compared to 1.6% TIPS and it is only kicking out less than 15,000 a year in real dollars by year 30. You have to survive more than 50 years before you break even with the 30 year TIPS fund.

If we drop down to 4% inflation the nominal annuity is providing longevity protection to the tune of 170k real dollars if you live 40 years, which provides 4 of the 10 years of additional income.

The TIPS fund needs something like 4 extra years of longevity protection and the annuity needs something like 4 extra years of inflation protection.

It's looking like 50% TIPS and 50% nominal annuity with 4 years of expenses has the best features:
... 10% deviation in annual payments due to good or bad annual inflation (2.5% to 5.4%)
... 4 years of additional expenses to cover 2 years of longevity risk and 2 years of inflation risk

100% TIPS plus 4 years of expense
... 20% deviation in annual payments due to good or bad annual inflation (2.5% to 5.4%)
... 4 years of additional expenses to cover 4 years of longevity risk

100% annuity plus 4 years of expenses
... 20% deviation in annual payments due to good or bad annual inflation (2.5% to 5.4%)
... 4 years of additional expenses to cover 4 years of inflation risk
Last edited by abc132 on Mon Dec 05, 2022 5:47 pm, edited 1 time in total.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by vineviz »

abc132 wrote: Mon Dec 05, 2022 5:45 pm I think it is fair to say that a nominal annuity doesn't provide any longevity protection in the case of 5.4% annual inflation.
It might be fair to say it, but it’s not true.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by abc132 »

vineviz wrote: Mon Dec 05, 2022 5:46 pm
abc132 wrote: Mon Dec 05, 2022 5:45 pm I think it is fair to say that a nominal annuity doesn't provide any longevity protection in the case of 5.4% annual inflation.
It might be fair to say it, but it’s not true.
Where is the analysis incorrect? Choose mine or Bill's as we both got the same value after 30 years with 5.4% inflation.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by Fremdon Ferndock »

What are we calling "longevity protection?" Sometimes helps to know what we're talking about to help determine if someone knows what they're talking about.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by Lawrence of Suburbia »

David Jay wrote: Mon Dec 05, 2022 2:00 pm
Lawrence of Suburbia wrote: Thu Dec 01, 2022 3:07 amIsn't that kinda one of those apocalyptic worries that paralyzes someone trying to make a decision? I mean, the U.S. government could default on its bond payments; a future congress might slash or defund Social Security; WWIII might break out, with the U.S. homeland devastated; etc. etc.
You left out the mass-extinction asteroid strike.
D'OH!! Now I'm going to have lower my SWR from 2% to 1.8% ... grrrr ... frustration
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by Lawrence of Suburbia »

Fremdon Ferndock wrote: Mon Dec 05, 2022 6:15 pm What are we calling "longevity protection?" Sometimes helps to know what we're talking about to help determine if someone knows what they're talking about.
Longevity protection for me means -- my portfolio balance is zero, I'm homeless ... but I can still afford coffee!
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by vineviz »

abc132 wrote: Mon Dec 05, 2022 5:45 pm I think it is fair to say that a nominal annuity doesn't provide any longevity protection in the case of 5.4% annual inflation. The 70,608 nominal annual payment I found available today from a 1,000,000 purchase ends up with a budget short of 190k as compared to 1.6% TIPS and it is only kicking out less than 15,000 a year in real dollars by year 30. You have to survive more than 50 years before you break even with the 30 year TIPS fund.
A $1,000,000 TIPS portfolio will generate $40k/year in real income for 30 years based on today's yields.

The same $1,000,000 in a SPIA for a 65 year old man with no death refund and a 4% fixed COLA will generate $53,420 in income in year 1 based on today's quotes, which is more than the TIPS portfolio generates.

Assume a constant rate of inflation of 5.5%.

A retiree who lives on $40k real from the nominal fixed COLA annuity can do so for 35 years (instead of just 30) if they reinvest the difference at a nominal rate of 2% (longer if we assume they reinvest the excess in a TIPS mutual fund) and withdraw from that fund when inflation overtakes the 4% fixed-COLA SPIA

Year 36 would be the first year the SPIA retiree saw their real income drop below the initial $40k, and only to $36k. Even at year 41, at the ripe old age of 106, the SPIA retiree still has a real income that is 75% of what they started with. The 100% TIPS ladder retiree has been bankrupt for over a decade at that point.

Image

Image
Last edited by vineviz on Mon Dec 05, 2022 7:01 pm, edited 3 times in total.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by Northern Flicker »

Fremdon Ferndock wrote: Mon Dec 05, 2022 6:15 pm What are we calling "longevity protection?" Sometimes helps to know what we're talking about to help determine if someone knows what they're talking about.
Longevity protection is funding an income stream until death. If not done with an annuity, you have to decide on an age to which to fund.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by Bill Bernstein »

Year 36 would be the first year the SPIA retiree saw their real income drop below the initial $40k, and only to $36k. Even at year 41, at the ripe old age of 106, the SPIA retiree still has a real income that is 75% of what they started with. The 100% TIPS ladder retiree has been bankrupt for over a decade at that point.
Well, yes, but your annuitant's wife might not be too happy about the absence of a survivor benefit, or the A+ rating.

I suggest you rerun things with an A++ company, since we're comparing with the US Treasury, and add survivor benefit so your annuitant's wife doesn't divorce him, as I did in my analysis. :wink:
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by David Jay »

Lawrence of Suburbia wrote: Mon Dec 05, 2022 6:37 pm
David Jay wrote: Mon Dec 05, 2022 2:00 pm
Lawrence of Suburbia wrote: Thu Dec 01, 2022 3:07 amIsn't that kinda one of those apocalyptic worries that paralyzes someone trying to make a decision? I mean, the U.S. government could default on its bond payments; a future congress might slash or defund Social Security; WWIII might break out, with the U.S. homeland devastated; etc. etc.
You left out the mass-extinction asteroid strike.
D'OH!! Now I'm going to have lower my SWR from 2% to 1.8% ... grrrr ... frustration
:wink:
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by abc132 »

vineviz wrote: Mon Dec 05, 2022 6:57 pm The same $1,000,000 in a SPIA for a 65 year old man with no death refund and a 4% fixed COLA will generate $53,420 in income in year 1 based on today's quotes, which is more than the TIPS portfolio generates.
My example was based on spousal benefits and is clearly stated in my earlier posts.

I'm still confused what you think you are disagreeing with.
abc132 wrote: Mon Dec 05, 2022 3:34 am The current rate from immediateannuities.com from the state I picked:
65 year male with 65 year old female secondary: 1 million buys 5884 per month
With 5.4% inflation the TIPS pays out 1.258 vs 1.067 million or +190,700 real dollars
Breakeven is 3.93% inflation where each pays out 1.258 million real dollars.
With 2.5% inflation the TIPS pays out 1.258 vs 1.425 million or -242,500 real dollars.
Average male expectancy is 17 years and for a couple single survivor average is 24 years. These two things should not be compared with equal years of longevity if we are talking about longevity protection. The single male only needs 25 years of life expectancy to be comparable with a 30 year span for a couple.

For comparison the single male leaves an expected inheritance of
137,000 with no COLA
87,000 with the 4% COLA
420,000 with the 30 year TIPS ladder.

It's difficult to call these things equal.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by vineviz »

Bill Bernstein wrote: Mon Dec 05, 2022 7:18 pm
Year 36 would be the first year the SPIA retiree saw their real income drop below the initial $40k, and only to $36k. Even at year 41, at the ripe old age of 106, the SPIA retiree still has a real income that is 75% of what they started with. The 100% TIPS ladder retiree has been bankrupt for over a decade at that point.
Well, yes, but your annuitant's wife might not be too happy about the absence of a survivor benefit, or the A+ rating.

I suggest you rerun things with an A++ company, since we're comparing with the US Treasury, and add survivor benefit so your annuitant's wife doesn't divorce him, as I did in my analysis. :wink:
Is divorce a bug or benefit? I’ll let readers decide.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by dknightd »

Inflation is just one of many risks.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by vineviz »

abc132 wrote: Mon Dec 05, 2022 10:33 pm
vineviz wrote: Mon Dec 05, 2022 6:57 pm The same $1,000,000 in a SPIA for a 65 year old man with no death refund and a 4% fixed COLA will generate $53,420 in income in year 1 based on today's quotes, which is more than the TIPS portfolio generates.
My example was based on spousal benefits and is clearly stated in my earlier posts.

I'm still confused what you think you are disagreeing with.
I'm disagreeing with this statement:
abc132 wrote: Mon Dec 05, 2022 5:45 pm I think it is fair to say that a nominal annuity doesn't provide any longevity protection in the case of 5.4% annual inflation.

You're right, I overlooked that you were using a joint annuity instead of single life. Apologies for that.

Rerunning with a joint survivor benefit does reduce the initial SPIA payout, however it doesn't change the basic conclusion: a SPIA provides income longer than 30 years IF the annuitants live longer than 30 years, which is the very definition of "longevity protection".

I re-ran things with the joint annuity, and here's a graph of the cumulative income in the case of the 5.4% inflation assumption you proposed earlier.

Image

If the annuitants pass away before 30 years, the length of the TIPS ladder, it is true they'll have received more cumulative real income.

If one of the annuitants lives for 40 years, their cumulative real income with the SPIA is much greater. Even at 35 years the SPIA will have produced more real income, and there's a 20% chance that one of the annuitants will make it that long (a greater chance than experiencing average inflation of 5.4% over 30 years, BTW). That's what "longevity protection" is about.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by NiceUnparticularMan »

Blue456 wrote: Sun Dec 04, 2022 5:28 pm
NiceUnparticularMan wrote: Sun Dec 04, 2022 10:44 am
Blue456 wrote: Sun Dec 04, 2022 5:34 am Equities have historically kept up with inflation over longer duration of time
That has not always been true in all times and places, and is particularly less likely to be true in a given period if stock pricing has gotten historically high such that expected real stock returns have gotten historically low.
For anybody who is US only in equity. For those of us who are diversified in international markets this is not an issue.
I'd agree it is less of a pressing issue. I'd still suggest that the possibility of a globally-diversified stock portfolio returning less than inflation over the next long period is non-trivial.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by dknightd »

What risk do you want to take? Inflation, or, living longer than you planned? Or perhaps working and saving longer than you needed to. Russian Roulette is a horrible concept. Diversify! And hope for the best. I would certainly not put a bullet in a gun and point it at my head!
Last edited by dknightd on Tue Dec 06, 2022 8:13 am, edited 1 time in total.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by NiceUnparticularMan »

Northern Flicker wrote: Mon Dec 05, 2022 4:52 pm I believe that longevity risk likely is the more expensive risk to hedge
This is a very academic way of putting this, but for what it is worth, this seems very likely to be true to me. Simply because annuities are an efficient way to pool longevity risk, and self-insuring against longevity is typically going to be quite inefficient in comparison. In contrast, from Treasury/TIPS pricing, it seems entirely possible the market cost of unexpected inflation hedging is quite low. I still find that a bit puzzling, but it is what it is.

Not that I don't think we need a full proof of concept anyway (for ideas like a SPIA + CCF strategy, say), but this sure does seem like a plausible hypothesis to me.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by dknightd »

This thread should probably be closed. Pointing a gun at your head is no way to deal with not having enough money!
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by Indyhou »

This has been a great thread- has a lot of good information and “food for thought”. Its been particularly interesting to me since we’re in the examples pretty much match our actual situation (ie me and my wife will turn 65 next year).

The only issue I have with the examples discussed is that they don’t include the effect of US Social Security benefits. We’re close enough to claiming them that I feel that it’s pretty certain that they will be there when we decide to claim them. I suspect that considering that benefit will make both scenarios (ie TIPS ladder and SPIA of various COLAs) look better.

If I get a chance I’ll start another thread looking at this (I think there’s enough info in Dr Bernstein’s article to replicate the examples). If anyone else wants to take a shot at this of course feel free…

Instead of a TIPS ladder/SIPA assuming a constant cashflow from age 65 I’d consider a cashflow of:

a. 100% of your required cashflow from age 65 6o 70.
b. 100% of your required cashflow less SS benefit from age 70 to ????

As an aside, a couple of months ago I created a TIPS ladder to cashflow our estimated expense less SS benefits for the next 20 years (taking Bobcat2’s suggestion to extend it only to your (approximate) life expectancy). My reasoning was that (at that time) TIPS were cheap but not at historical lows… I considered it a shift in how I implemented part of my bond portfolio.

I looked briefly at various SPIA options but decided I didn’t want to go down that one-way street at this point in my retirement.
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Re: Bill Bernstein: "Playing Inflation Russian Roulette in Retirement"

Post by nedsaid »

vineviz wrote: Tue Dec 06, 2022 7:07 am
abc132 wrote: Mon Dec 05, 2022 10:33 pm
vineviz wrote: Mon Dec 05, 2022 6:57 pm The same $1,000,000 in a SPIA for a 65 year old man with no death refund and a 4% fixed COLA will generate $53,420 in income in year 1 based on today's quotes, which is more than the TIPS portfolio generates.
My example was based on spousal benefits and is clearly stated in my earlier posts.

I'm still confused what you think you are disagreeing with.
I'm disagreeing with this statement:
abc132 wrote: Mon Dec 05, 2022 5:45 pm I think it is fair to say that a nominal annuity doesn't provide any longevity protection in the case of 5.4% annual inflation.

You're right, I overlooked that you were using a joint annuity instead of single life. Apologies for that.

Rerunning with a joint survivor benefit does reduce the initial SPIA payout, however it doesn't change the basic conclusion: a SPIA provides income longer than 30 years IF the annuitants live longer than 30 years, which is the very definition of "longevity protection".

I re-ran things with the joint annuity, and here's a graph of the cumulative income in the case of the 5.4% inflation assumption you proposed earlier.

Image

If the annuitants pass away before 30 years, the length of the TIPS ladder, it is true they'll have received more cumulative real income.

If one of the annuitants lives for 40 years, their cumulative real income with the SPIA is much greater. Even at 35 years the SPIA will have produced more real income, and there's a 20% chance that one of the annuitants will make it that long (a greater chance than experiencing average inflation of 5.4% over 30 years, BTW). That's what "longevity protection" is about.
Vineviz provided longevity protection and saved a marriage at the same time! Wow!
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