Investing During Retirement

Evaluated this route

AKHalea — Sun, 09 Sep 2007 00:07:00 GMT

before when I retired a few years ago. My wife & I were concerned about having some steady income stream and an immediate fixed income annuity seemed to have that solution. We evaluated it from many angles and in the end decided not to do it at that time (3 years ago).

Instead, we decided that we would be better off, at least in the first bunch of years of retirement getting a better return than the 4.5 to 4.6% effective rate we would get in the annuity (at that time). The rates might be better in future when the Fed increases rates (we thought). We decided to to use the annuity's rate (not the payout) as our hurdle rate for the lumpsum rollover investment.

For a stop-gap measure till SS, we also decided that we would buy slightly leveraged muni bond CEFs that provided a nice 5.8-6% tax free (in a different taxable a/c), to provide monthly income to cover the essentials (mortage etc). Then the rollover Lumpsum money was invested in a rollover IRA and monitored as a separate a/c to keep tabs on the returns. I am happy we did that as I show over 5% more return than the annuity effective rate.

As we age, I think that the annuity option may be evaluated again, just to safeguard against us both getting old, forgetful and senile (as Roberta has brought up in another thread). Cheers...Anil

I skimmed the paper before

mlebuf — Sat, 08 Sep 2007 06:42:00 GMT

I read the comments above. As I read over the paper, my initial impression was that it's a veiled annuity sales pitch. To be fair, I did not read it carefully though. I guess we are all different and some need the security of a guaranteed check for life more than others. Some of us, myself included, will/do get an employee pension and Social Security which function as a nice annuities that we can't outlive. As for my investments, my choice is to go with a balanced portfolio, suitable for my risk tolerance and time horizon. Other than the pensions, the only longevity risk protection I have is LTC insurance. I'm 65 and that's the plan for now.

Best wishes,
Michael

Ron

orygunduck — Mon, 03 Sep 2007 18:08:00 GMT

Some good points, but making the committment to an annuity, whether for life or for a period certain, comes with costs other than the potential opportunity cost of a slightly lower yield. These costs are:

illiquidity
premature death (with a life annuity)
insurer default
inflexibility
purchasing power

In today's world, a money market fund would overcome 3 of the above risks, but then it would add interest rate risk and creditor risk. But if liquidity and the ability to leave an inheritance would have to be weighted against the 'guarantee' of a life (or period certain) income.

As you say, the right answer is 'it depends'.

And a fine point: the yield on a $100,000 lump sum paid to an insurer, who pays $6,600.00/year, beginning one year after the initial lump sum is paid (an ordinary annuity), for a period of 28 years, provides an annualized yield of 4.8455%. However, if the first annual payment is made when the lump sum is paid (an annuity due), the yield rises to 5.3253.

But, I think more realistically, if you go to monthly compounding, the yield on the ordinary annuity goes to 4.9403 and for the annuity due, goes to 4.9785.

BruceM

RE: #12

rs0460a — Mon, 03 Sep 2007 16:23:00 GMT

Using the annualized return over 28 years, the actual interest rate is 4.62793%. The 6.6% is the payout rate.

This may seem low (remember the 20% CD's of the early 80's?) or even against today's short-term MM rates of 5%.

However, when I "plug in" my monthly income received from this annuity into a financial forecast tool (such as Vanguard's Financial Engines or Fidelity's Retirement Income Planner) it shows quite a change to the "survivability" of the plan (disclaimer - our plan already meets our needs; the annuity just provides a larger estate for our named charities).

I realize that you can greatly argue that you "can do better". I won't even debate that. However, in our case, to remove some of the short-term "maybe's" (changes in interest and stock market return rates) along with knowing that only a small portion of our retirement portfolio is used for this immediate annuity (and removing the temptation to "do better") adds to our "sleep factor". Like I stated before, the immediate annuity is primarily to act as "gap insurance" till we get to SS (and have an inflation protected return income vehicle).

Also remember that we can buy more IM's in the future if the return rates are "more favorable" and the monthly income amounts are higher due to our "futue advanced age".

Again, the answer is "it all depends" (on whether an IM makes sense) for your situation.

- Ron

Ron, #10

Oicuryy — Sun, 02 Sep 2007 20:45:00 GMT

Hi Ron,

As an example, the actual guaranteed interest on our immediate annuity (executed in July of this year) has a payout equal to 6.6%. By some miracle, if my wife and/or I live beyond the age of 87, the return will be higher. It is computed at 6.6% against the "buy in $$" against a guaranteed 28 year period. As you know, since annuities are an "insurance product", we are insuring that we will get at least a 6.6% return over that 28 year period.

It is a little unclear whether that 6.6% is the payout rate or the interest rate. The payout rate is the payment amount divided by the purchase price. The interest rate is the rate a bank savings account would have to pay to provide the same withdrawals.

For example, suppose I paid $100,000 for an annuity that will make twenty-eight annual payments. If each payment is $6,600, then the payout rate is 6,600/100,000 or 6.6%. The corresponding interest rate is 4.8%, calculated using the Excel RATE function like so
=RATE(28,6600,-100000).

On the other hand, if the interest rate is 6.6% then the annual payments would be $7,923 and the payout rate would be 7.9%. This is calculated using the Excel PMT function.
=PMT(0.066,28,-100000)

The interest rate is the better number to use to compare to other investment rates of return such as the 6% yield to maturity of a bond. Unfortunately, most insurance companies do not disclose the interest rate of their annuities. One that does is brkdirect.com.

The unwillingness of insurance companies to reveal important information may be one reason why that Fidelity survey found that "One-half of pre-retirees and nearly as many retirees would agree that they do not know enough about annuities or their benefits in order to make a decision to purchase."

Ron

Ron,

bobbinm — Sun, 02 Sep 2007 19:24:00 GMT

I agree. There is no right answer when it comes to an annuity purchase............only the right answer for you.

I don't believe any judgment can be made regarding the intelligence or idiocy of a retiree based solely on whether or not an SPIA is included in his retirement plan.
Bobbi

Maybe not 4 U, but maybe for others...

rs0460a — Sun, 02 Sep 2007 19:02:00 GMT

Bobbi,

Just a few items in response to the quotes used in your reply, for your consideration. I believe you know that we have executed an immediate annuity with 10% of our retirement portfolio, and as the months go on, we feel more "comfortable" with our decision. I will admit that it did take a lot of "soul searching" to come up with a decision that resulted in our using this vehicle as part of our retirement income/ investment plan.

The quote of "Long term high grade corporate bonds are currently paying 6% annually" questions if the words "long term" and "current" will remain for the period of the payout period. As an example, the actual guaranteed interest on our immediate annuity (executed in July of this year) has a payout equal to 6.6%. By some miracle, if my wife and/or I live beyond the age of 87, the return will be higher. It is computed at 6.6% against the "buy in $$" against a guaranteed 28 year period. As you know, since annuities are an "insurance product", we are insuring that we will get at least a 6.6% return over that 28 year period. Yes, long term high grade corporate bonds could return more or less than the stated 6%, but then we can plan/guarantee the 6.6% in our retirement income plan.

The comment of "For the average American with an average lifespan, an annuity is not a financially winning investment" is not necessarily the reason why we purchased the product. In our case, there is a six to seven year period from the time we have/will retire till we draw SS. The annuity was purchased to provide additional income (e.g. "gap insurance") to provide income till we indeed draw SS. In the end, we're all in the grave, and I don't think we look at "winning" in the financial case. I believe (anyway, at least for us) the goal is to provide a steady stream of retirement income - not to become "the richest person in the graveyard".

As far as the discussion related to the reduction in purchasing power, while I'll agree 20+ years down the road our income from the annuity will be worth little, the rationale is to get us to SS (which is inflation indexed). Our 10% "investment" is currently providing us 25% of our monthly gross income. Over the next 6-7 years while we wait for SS, its value will be reduced, but again, it's not the "tool" (e.g. annuity) but how you use that tool for the situation.

Like they say, "If all you have is a hammer, everything looks like a nail". An immediate annuity is not a hammer, and retirement income is not a nail. You have to have the proper "conditions" to make it work. For those that can use an immediate annuity to solve their retirement income challenges, great. If not, don't just buy an immediate annuity to fix your "problem". However, if your solution needs a "hammer" (as ours did), an immediate annuity makes a fine "hammer". Also remember that we still have 90% of our retirement portfolio to take advantage of any "investment opportunities".

Again, the correct answer is "it all depends".

- Ron

Irrational?

bobbinm — Sun, 02 Sep 2007 03:37:00 GMT

Bob, I'm surprised you would insinuate that those who view Fidelity's research paper as marketing material are irrational. This paper is not the first from Fidelity suggesting than annuities may be the magic bullet for retirees. They all end with a link to purchase information.

I did not respond to you message originally because, as you know, I have researched the use of an SPIA for my situation and decided that it does not fit my desire to leave a substantial estate nor is it appropriate given then rather limited lifespans of my family members. I don't believe that Fido and Milevsky spend enough time discussing situations where an SPIA purchase is not optimal.

Here's an interesting column:

$tarrBuck Report for August 6, 2006: Immediate Annuity?
By R. M. Starr
An immediate life annuity is an insurance product that pays you a regular income for life, in exchange for a lump sum to purchase it now. It's the precise opposite of life insurance - life insurance insures you against dying too soon; a life annuity insures you against outliving your money.

You pay for an immediate annuity now and it starts paying off directly, a check next month and each month thereafter. That makes it a lot simpler and more reliable than a deferred annuity (which starts paying off in the distant future) or a variable annuity (whose payoffs are keyed to the stock market).

Hammond Blackwell has managed his own money throughout his life. At his next birthday he'll be 70 years old. Hammond's mother just celebrated her 97th birthday. Hammond hasn't been planning to live to 97 - but in case he does, he'd like some income security. He's looking into buying a life annuity as a 70th birthday present for himself.

Hammond gets a quote from an insurance broker: For $500,000 now, Hammond can receive a monthly income of $3800 for life. If he lives as long as his mother, Hammond can receive $1,230,000, more than twice as much as his cost. But that calculation ignores the time value of money. Long term high grade corporate bonds are currently paying 6% annually. At that rate, $3800 per month for 27 years is currently worth about $600,000, more than Hammond's cost but not such a bonanza. Nevertheless, that would be a good, and profitable deal. To do this bit of figuring Hammond could use the NPV function on Excel or go to http://www.moneychimp.com/calculator/retirement_calculator.htm .

But Hammond is not likely to live to 97. He looks up his life expectancy at http://www.cdc.gov/nchs/data/nvsr/nvsr54/nvsr54_14.pdf . At age 70 he's likely to live another 13.5 years. At that rate, for his $500,000 he'll collect $616,000. That's more than it cost him, but actually, considering the time value of money, that stream of payments for 13.5 years is only worth $415,000. Insuring against outliving his money is costing Hammond $85,000. Is that too much? The break-even life expectancy is 18 years, 4.5 more than average.

There's a reason it costs extra to buy the annuity. Not everyone buys one. People who don't expect to live very long don't buy annuities. So the life expectancy of the average annuitant is longer than the general population's. For the insurer to break even, the annuity has to be priced assuming Hammond will live longer than the average American man. For the average American with an average lifespan, an annuity is not a financially winning investment.

Saving for retirement
There's always the alternative of saving, investing and spending income and some principal. Hammond can create his own annuity plan. For $ 500,000 over 27 years, Hammond figures he can arrange a monthly income of $3150. That's less than the annuity, but he'd maintain control. Or he could start with $600,000 and maintain the payout of $3800 for 27 years. But what if he lives too long? Mom is still going strong at 97. That's the insurance value of the life annuity; it goes on as long as you do.

What about Inflation?
Even at moderate inflation rates, the value of $3800 a month can be cut in half over 27 years. It's hard to find an annuity with a cost of living escalator. There are annuities available with a monthly payment that grows by a fixed percentage each year. But the starting monthly payment is reduced to make up for it. Not a good deal. To handle inflation, recognize that the purchasing power of the monthly payment is going to go down: save part of each month's income in the early years recognizing the need to supplement the annuity later -- or plan to buy a second annuity (and set aside money for it now) in the future.
(c) Copyright R. M. Starr 2006

So you see, they are not the best choice for everyone.
Bobbi

Bob

pkcrafter — Sun, 02 Sep 2007 00:52:00 GMT

As I mentioned in #2, there was at least one other article on this subject in the past few weeks. I can't recall where I saw it, but it seemed to make sense. I am skeptical of the variable annuity, but I'll try to locate the other article and see who wrote it.

Paul

What has been known for ever so long!

uphaus — Sat, 01 Sep 2007 18:09:00 GMT

click here Note paragraph #3 of the statement dated February 2001 (somebody's been asleep for L O N G time).

Logic 101: the truth of any statement is NOT determined by the person who uttered it. Even liars can sometimes tell the truth, and truth-tellers can sometimes lie.

Logical fallacy (again Logic 101): when all else fails try an ad hominem "argument"--i.e., appeal to prejudice. And, wow, have some of the responses been marked by nothing but prejudice.

On the particular topic of the Fidelity link, it's perfectly obvious that the Bogleheads (accused of being so intolerant in some quarters) are, in fact, much more capable of rationally evaluating the sort of case presented by the Fidelity paper. Adios. Bob U.

Ron #2

bob90245 — Fri, 31 Aug 2007 19:03:00 GMT

Thank you for those links. It's a real eye-opener.

bob90245

Bang!

uphaus — Fri, 31 Aug 2007 18:20:00 GMT

Quite a "conversation!" Not wholly unexpected. Good luck. Bob U.

Let's look at background

meyerr — Fri, 31 Aug 2007 17:59:00 GMT

We're talking about a group that never planned to fund their own retirement unlike our children. We went off to work expecting to stay with the same company and retire with a gold watch, a pension and SS after SS. Our mothers stayed home; for females our job choices were larely, teacher, nurse, secretary and we were expected to leave the employment ranks when we became pregnant.

Boy did our world change and many of us came late to the investing world, particularly equities b/c only the wealthy invested in stocks. We used savings accounts and CD's. Our parents remembered the depression and taught us about safety. Particularly for females, our workplace choices were fixed annuities; that's why the insurance industry dominates that market.

We grew up. College for our children was assured. We could afford our mortgages, if our house wasnt' actually paid for and we started looking at retirement and there was the stock market taking off and we joined the frenzy and lost our shirts and savings.

Now we're actually entering retirement and not getting any more pay checks and horribly fearful of not having enough money and/or running out of money. And there's the nice insurance salesman with his promises and assurances. He tells us we can have market returns w/o risk of losing our money, guaranteed income and pie in the sky and we believe.

Stock tip - buy insurance companies that sell annuities and LTCI. If they can be paying salesmen 10-20% to sell the product, how much are they making. Remember the average investor doesn't hang out on these boards.

Roberta

Remember,

orygunduck — Fri, 31 Aug 2007 17:28:00 GMT

insurers are the grand masters of product sales, and the envy of the product sales industries like autos, vacuums and real estate.

In this 'research' paper, clearly the 'noted researcher' is cherry picking those variables that will shed the most favorable lite on the use of annuities as the solution to these horrible events that are going to leave new retirees destitute if they don't do something.

I'm often asked how one can tell whether the 'research' they are reading is reputable, a partial truth or simply hogwash. The giveaway, from my perspective, is the time the researcher's spent on the 'bad stuff'. For annuities, the 'bad stuff' includes providing objective research (as opposed to cherry picking data to overcome objections, which is what these authors did) on the effects of inflation, the net cost to provide the life (or period certain) income stream, liquidity requirements in a retiree's portfolio, the risk of losing part of one's investment with premature death, the loss of a legacy and default risk, and the consequences of this.

It would seem that my friends at Fido are starting to ramp-up their pre-retirement marketing. It'll be entertaining to sit back and watch this stuff unfold :-)

BruceM

Shooting the messenger

Oicuryy — Fri, 31 Aug 2007 15:27:00 GMT

No, Bob, not you. These shots are at Moshe Milevsky, co-author of the sales brochure you linked to.

Milevsky is paid by the insurance industry. He is executive director of the Individual Finance and Insurance Decisions Centre. IFID is a non-profit corporation funded in large part by insurance companies. Milevsky is also president of the Quantitative Wealth Management Analytics Group. QWeMA is a private, for-profit company that develops marketing software for insurance companies.

Despite his academic credentials, I wouldn't trust Prof. Milevsky to present an unbiased view of annuities. Readers should be skeptical of his writings.

Ron