Author Topic: Immediate Annuity only if you can't survive on a 4% withdrawal rate?  (Read 1805 times)

FIREin2018?

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Immediate Annuities are basically an insurance policy where you get a lifelong income stream.

you're basically betting that the Immediate Annuity will pay more in your lifetime than a '40% stock/60% bond' portfolio while withdrawing at 6%+ per year.
If you're only withdrawing 4% per year, then you dont need an Immediate Annuity since it's unlikely you'll outlast your 40/60 portfolio.

ie: $300k nest egg
4% withdraw rate = $12k/year

but you need $20k/year (on top of social security) to meet expenses.
$20k/$300k = 6.67% withdrawal rate

So is the title of my thread correct?
If not, why not??

Xlar

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Re: Immediate Annuity only if you can't survive on a 4% withdrawal rate?
« Reply #1 on: March 14, 2018, 10:26:19 AM »
I believe that one of the main problems with an annuity in the long term is that it is not inflation adjusted! This means that while you have a higher 6-7% withdrawal rate early on inflation will decrease the purchasing power of the annuity below 4%. The 4% rule includes adjusting your withdrawals upwards every year to compensate for inflation.

The other problem with an annuity is that you don't get your capital back at the end! If you run the 4% rule in cFiresim you'll see that in the majority of 30 year periods you actually end up with more capital left (adjusted for inflation) than when you started!

yachi

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Re: Immediate Annuity only if you can't survive on a 4% withdrawal rate?
« Reply #2 on: March 14, 2018, 11:37:00 AM »
You got me curious so I just ran Fidelity's annuity calculator, selecting an age of 35, income starting this year, and a 2% annual increase option.  With an $850,000 investment they would pay out only $2,053 per month, so a 2.9% "withdrawal rate".
The 2% annual increase is current inflation, but who knows what it'll be for the next 50 years.  There's also no minimum payout or death benefit, so they keep your money no matter what.

I suggest a new thread title:
Immediate Annuity: only if you can't survive on a 4% withdrawal rate while spending less than 3%

Financial.Velociraptor

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Re: Immediate Annuity only if you can't survive on a 4% withdrawal rate?
« Reply #3 on: March 14, 2018, 03:25:12 PM »
You'll be hard pressed to find an annuity paying 6% in the US right now.  Many are offering less than 2%!

Eric

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Re: Immediate Annuity only if you can't survive on a 4% withdrawal rate?
« Reply #4 on: March 14, 2018, 03:40:08 PM »
I believe that one of the main problems with an annuity in the long term is that it is not inflation adjusted! This means that while you have a higher 6-7% withdrawal rate early on inflation will decrease the purchasing power of the annuity below 4%. The 4% rule includes adjusting your withdrawals upwards every year to compensate for inflation.

You can solve this problem by purchasing an inflation adjusted annuity.

The other problem with an annuity is that you don't get your capital back at the end! If you run the 4% rule in cFiresim you'll see that in the majority of 30 year periods you actually end up with more capital left (adjusted for inflation) than when you started!

This is even less of a problem, since dead people generally have very little use for money.

Eric

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Re: Immediate Annuity only if you can't survive on a 4% withdrawal rate?
« Reply #5 on: March 14, 2018, 03:48:29 PM »
So is the title of my thread correct?
If not, why not??

Because it's a hedge against a downside risk.  You don't actually know if you can survive on 4% or not until after the fact.  Note that the older you get, the higher the payout.

Mighty-Dollar

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Re: Immediate Annuity only if you can't survive on a 4% withdrawal rate?
« Reply #6 on: March 18, 2018, 02:57:02 PM »
Immediate Annuities are basically an insurance policy where you get a lifelong income stream.

you're basically betting that the Immediate Annuity will pay more in your lifetime than a '40% stock/60% bond' portfolio while withdrawing at 6%+ per year.
If you're only withdrawing 4% per year, then you dont need an Immediate Annuity since it's unlikely you'll outlast your 40/60 portfolio.

ie: $300k nest egg
4% withdraw rate = $12k/year

but you need $20k/year (on top of social security) to meet expenses.
$20k/$300k = 6.67% withdrawal rate

So is the title of my thread correct?
If not, why not??
Left out of your first sentence is the word ADEQUATE! That income stream becomes inadequate if you live long enough. There's a TRADE OFF for getting that initial higher rate of income. Eventually that income rate will pale in comparison to what you should get with a traditional bond/ stock mix. Why immediate annuities leave you in poverty: https://www.youtube.com/watch?v=QDUbQeZvJ9g
Also from 1970 - 2010, 28% stocks / 72% bonds was the lowest risk allocation -- not 40/60.
Heirs also get nothing or at least a zero return on investment if you die before your actuarial life expectancy.
And 4% is a worst case scenario. That's assuming that we hit nasty times and we hit nasty times immediately. More often than you you will be able to take out more than 5%.
Stop worrying about the 4% rule: https://www.youtube.com/watch?v=C-Ni0tWFQfM
Quote
You can solve this problem by purchasing an inflation adjusted annuity.
Insurance companies are not playing Santa Claus. You can't just flip a switch and magically have a better annuity. They are going to compensate for giving you inflation adjusted payments. Usually that means lowering the initial payment rate -- all of a sudden traditional investing looks even better! Also they'll probably remove any death benefit if you die before the principal is paid out.
With index annuities they generally just give you back your money so that when it's all said and done you earned zero ROI.
« Last Edit: March 18, 2018, 03:04:10 PM by Mighty-Dollar »

Eric

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Re: Immediate Annuity only if you can't survive on a 4% withdrawal rate?
« Reply #7 on: March 19, 2018, 10:05:02 AM »
Quote
You can solve this problem by purchasing an inflation adjusted annuity.
Insurance companies are not playing Santa Claus. You can't just flip a switch and magically have a better annuity. They are going to compensate for giving you inflation adjusted payments. Usually that means lowering the initial payment rate -- all of a sudden traditional investing looks even better! Also they'll probably remove any death benefit if you die before the principal is paid out.
With index annuities they generally just give you back your money so that when it's all said and done you earned zero ROI.

Did I imply that it was a free annuity?  If so, then allow me to correct that impression.  They are not free.  You'll need to pay for it.  That's why I used the word "purchasing".  Glad we could get on the same page.

Padonak

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Re: Immediate Annuity only if you can't survive on a 4% withdrawal rate?
« Reply #8 on: March 19, 2018, 10:42:33 AM »
Ptf

Mr Mark

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Re: Immediate Annuity only if you can't survive on a 4% withdrawal rate?
« Reply #9 on: March 24, 2018, 10:24:09 PM »
Immediate Annuities are basically an insurance policy where you get a lifelong income stream.

you're basically betting that the Immediate Annuity will pay more in your lifetime than a '40% stock/60% bond' portfolio while withdrawing at 6%+ per year.
If you're only withdrawing 4% per year, then you dont need an Immediate Annuity since it's unlikely you'll outlast your 40/60 portfolio.

ie: $300k nest egg
4% withdraw rate = $12k/year

but you need $20k/year (on top of social security) to meet expenses.
$20k/$300k = 6.67% withdrawal rate

So is the title of my thread correct?
If not, why not??

Firstly the initial 4% is inflation adjusted, the basic annuity is not and over time will be worth a lot less.
Also you are thinking pre-tax, when what counts is after tax. A solid 70/30 portfolio will get you up to 90k+/yr tax free (federal tax). Annuity payments are taxed as ordinary income.

The insurance company doesn't have a magic investment wand and will be investing in bonds and index funds just like you. But they gain by paying you a bit from the money they got from the people who die. If you try to adjust for this by (1) getting an annuity that is inflation adjusted and (2) buying an annuity with guaranteed payout and/or spousal survival benefits the % goes way down.

There's a good reason annuity companies pay big bonuses to the financial salespeople who manage to get a sucker someone to buy an annuity. That bonus and their profit is coming from your money.

There are not many benefits of an annuity. One is that it will protect your money from Medicare claw back if you have to go into a care facility. Second it will stop you losing the money when you loose your marbles and in a fit of inspired dementia decide to invest all your stache in your favorite nurse's cousin's business opportunity or in crypto. Social security is almost certainly the only annuity you'll need. Make sure you have the minimum 40 points before you reach 62.

Mighty-Dollar

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Re: Immediate Annuity only if you can't survive on a 4% withdrawal rate?
« Reply #10 on: June 05, 2018, 03:09:09 AM »
Quote
You can solve this problem by purchasing an inflation adjusted annuity.
Insurance companies are not playing Santa Claus. You can't just flip a switch and magically have a better annuity.
Did I imply that it was a free annuity?  If so, then allow me to correct that impression.  They are not free.  You'll need to pay for it.  That's why I used the word "purchasing".  Glad we could get on the same page.
No. You implied that the FEATURE of adjusting for inflation is somehow free. If they give something then they will taketh away something else. Either way, expect a 1% - 3% internal rate of return, which ALL annuities will return in today's low interest rate environment.

Eric

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Re: Immediate Annuity only if you can't survive on a 4% withdrawal rate?
« Reply #11 on: June 05, 2018, 10:24:34 AM »
Quote
You can solve this problem by purchasing an inflation adjusted annuity.
Insurance companies are not playing Santa Claus. You can't just flip a switch and magically have a better annuity.
Did I imply that it was a free annuity?  If so, then allow me to correct that impression.  They are not free.  You'll need to pay for it.  That's why I used the word "purchasing".  Glad we could get on the same page.
No. You implied that the FEATURE of adjusting for inflation is somehow free. If they give something then they will taketh away something else. Either way, expect a 1% - 3% internal rate of return, which ALL annuities will return in today's low interest rate environment.

No I didn't.  Again, it's helpful to read the words that are written on the page.  Are inflation adjusted annuities a good deal?  No.  Do they exist?  Yes.  I didn't imply anything else.  Stop being obtuse.


DreamFIRE

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Re: Immediate Annuity only if you can't survive on a 4% withdrawal rate?
« Reply #12 on: June 05, 2018, 05:31:06 PM »
Firstly the initial 4% is inflation adjusted, the basic annuity is not and over time will be worth a lot less.
Also you are thinking pre-tax, when what counts is after tax. A solid 70/30 portfolio will get you up to 90k+/yr tax free (federal tax). Annuity payments are taxed as ordinary income.

If you purchase the annuity with after-tax dollars, when you withdraw, only the earnings are taxed.  Since you compared to paying capital gains taxes, you aren't talking about a retirement account using pre-tax dollars.

Quote
A solid 70/30 portfolio will get you up to 90k+/yr tax free (federal tax).

I assume this was in reference to $90K in capital gains not being taxable, which isn't usually the case, and certain isn't true for me:

https://forum.mrmoneymustache.com/investor-alley/stop-worrying-about-the-4-rule/msg1989875/#msg1989875

That's usually not the case, certainly not for a single person (I assume "Miss" implies single.)  For a single person, the 0% capital gains bracket is $0-38,600

If you had no other taxable income, you could add a $12,000 additional gains due to the standard deduction.

So, then you're up to $50600 of long term capital gains that you would pay 0% federal tax on, but ONLY if you had no other taxable income.   So $90K in capital gains would trigger taxes at the federal level.

Myself, I have to pay 15% on all my long term capital gains because I earn over $100K/yr of other income, well above the 0% capital gains tax level.

Of course, normally when selling shares that realize capital gains as opposed to dividends, the gain is only part of the amount you are pulling from the investment.  So a $30K gain, for example, from selling shares will mean you're actually pulling much more from your investment than $30K.

Mighty-Dollar

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Re: Immediate Annuity only if you can't survive on a 4% withdrawal rate?
« Reply #13 on: June 09, 2018, 08:42:25 PM »
Inflation adjusted annuities will lower your initial payments to compensate. Instead of 6% then you might get 5% or 5.X%. Then traditional investing just looks better and better. The 4% withdrawal rate is a WORST case scenario that assumes 1) nasty times and 2) those nasty times coming immediately. Even if someone retired 2 years before the 2000's "lost decade" you could have safely taken out about 5.2% per year and still maintained your principal and saw it grow. Now just imagine average or good times ahead!
https://www.youtube.com/watch?v=C-Ni0tWFQfM

MustacheAndaHalf

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Re: Immediate Annuity only if you can't survive on a 4% withdrawal rate?
« Reply #14 on: June 09, 2018, 09:32:42 PM »
The other problem with an annuity is that you don't get your capital back at the end! If you run the 4% rule in cFiresim you'll see that in the majority of 30 year periods you actually end up with more capital left (adjusted for inflation) than when you started!
This is even less of a problem, since dead people generally have very little use for money.
Or OP could spend some of the capital over time, rather than taking this all or nothing approach.  Using Vanguard's nest egg calculator to see what might happen:

Assuming 60% stocks/40% bonds... retiring with social security sounds like age 65 to age 95, so maybe 30 years:
4% withdrawal ($12k/yr) lasts 30 years 91% of the time
5.3% withdrawal ($16k/yr) lasts 30 years 71% of the time
6.7% withdrawal ($20k/yr) lasts 30 years 46% of the time

Note stock allocation has less of an impact than you might expect.  Using 80% stocks/20% bonds improves the 5.3% withdrawal scenario to a 73% chance of success, versus 71%.

Given the low fees in passive index funds, and the fact you get all of the returns with no insurance company middleman, it's probably your best option when the money is close.