Annuities

Preparing for life after work. RRSPs, RRIFs, TFSAs, annuities and meeting future financial and psychological needs.
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tomc
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Annuities

Post by tomc » 27 Sep 2009 20:09

Hello

I've looked around but I haven't seen a discussion of this question.

When is the right time to buy an annuity? My wife and I are both 40 and would like to retire in about 15 years. We have saved $200K towards retiring. Would it make sense to buy a deferred annuity now? Or is it better to invest the money in stocks and bonds for the next 15 years, and then buy an annuity?

Thank you in Advance for any replies.

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Post by Pickles » 27 Sep 2009 20:28

Others may answer your specific query but I want to point out there are lots of threads on annuities on the FWF.

If you use the FWF search function (see the 'search' button' under the FWF banner at the top of the page) you will find 15 separate threads dealing with annuities by simply typing the words annuity and annuities into the search box and clicking "check message title only".

Our search function ain't the easiest, but give it a try! You'd be amazed at the threads that don't appear in the first 2-4 pages of threads, simply because of the number of threads recently updated. The search function can help.
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Post by brucecohen » 27 Sep 2009 21:36

The older you are, the better the life annuity pricing. That's because the income stream is likely to run for less time. One rough rule-of-thumb is that people should resist annuitizing until their 70s.

Annuity rates reflect bond market rates. IIRC, rates on long-term govt bonds. So, the time to buy a deferred annuity would be when you think bond market rates are high. Currently, govt bond rates are very low.

One strategy to consider is moving your annuity-earmarked money into fixed income over the next 10 years or so. If interest rates rise, your bonds will be worth less but the intended annuity will also cost less. If interest rates fall, your bonds will cost more but the intended annuity will also cost more. If you accumulate enough to make multiple annuity purchases worthwhile, buy one per year for several years to hedge the risk of committing all money at once -- remember that annuity contracts are cast in stone.

Much of this consideration will depend on your outlook for inflation. If you share the view of many that we're in for an inflationary surge, you should wait to annuitize since rising inflation will push up interest rates.

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Post by sydney2 » 11 Oct 2009 10:21

A good friend is looking to buy an annuity and wanted my opinion. I don't like annuities as I have stated before on the forum, however I am throwing this out to see what the forum thinks of these rates.

Age 55 - 20 year guaranteed
Amount $500,000.
Quotes as follows:
Canada Life $3224.61 $1141.27 taxable portion
Great West same as Canada Life
Equitable Life $3136.07 $1028.99 taxable portion
Sun Life $3030.49 $947.15 taxable portion

Canada Life seems to be the best with income of $25,000 after tax per year.

This person has more than enough money to create his own income without purchasing this annuity, but since salary continuance has now been discontinued, he wanted something with a guarantee. My opinion is that he is losing control of the 500,000, that he could invest himself and get as good a return with these funds by investing elsewhere.

I would think that waiting until interest rates improve would give a higher guaranteed income than it does today. Need some additional objective opinions on this. Thanks

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Post by Shakespeare » 11 Oct 2009 10:29

55 is usually considered too early to buy an annuity. IIRC Milevsky says 70+ for a male, although I think that if you intend to buy in several tranches you can start earlier.
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Post by blonde » 11 Oct 2009 12:00

I DO NOT favor an annunity, regardless of the spin. It is all about SALES.

Never ever expect a rookie to make you rich.

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Post by marty123 » 11 Oct 2009 13:15

It looks like about 2% interest over 25 years.

If it were me, I'd consider buying 15 or 20 year government bonds yielding about 3.5-3.75% (~$18K/yr), and cashing capital to bring the total withdrawal to $25K. I'd then still have about $365K @ 70 or $300K @ 75. Then, annuitize for what should be $32-35K+, if interest rates are still about the same as these days. The problem with annuitizing at 55 is that your age group has too long a life expectancy left, so you're riding solely on (lowered) interest income.

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Post by scomac » 11 Oct 2009 14:49

marty123 wrote:It looks like about 2% interest over 25 years.
Nope. The interest earned on investment is 4.726% assuming that the annuity is for only the 20 year guarantee period. It isn't specified, but if this is a life annuity with a 20 year guarantee for a 55 year old male then I would say this is a pretty good deal especially if the quoted individual will be paying management fees on a competing $500K income producing portfolio. You have to factor in that if we're talking life annuity, the longer the annuitant lives beyond the guarantee period, the greater the ROI earned.
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Post by marty123 » 11 Oct 2009 21:46

scomac, i didn't add up the numbers, I just went with the $25,000/yr not noticing we're talking about after tax. For 20 years, it's close to 5%. Still far off my 2% :lol:

Sydney, the tax calculations or the taxable portion don't add up unless we're looking at nearly 100% taxes.

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Post by Spidey » 12 Oct 2009 15:45

I don't know if those rates are linked to inflation. If not, it seems to me that a bank perpetual preferred, currently yielding almost 6%, would be a better bet.
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Post by bones1 » 12 Oct 2009 16:11

Spidey wrote:I don't know if those rates are linked to inflation. If not, it seems to me that a bank perpetual preferred, currently yielding almost 6%, would be a better bet.
Yes, but preferreds are equities. And bank preferreds are non-cumulative. So, the bank can stop paying dividends on them (as long as they do the same for the common shares) anytime they want, and if/when they resume dividends they don't owe you a cent in back-pay. And then there's the situation they could go bankrupt and leave the holder with nothing, much like the Nortel preferred shares.

I'm not sure that someone looking for the safety of an annuity should be messing around with equities.

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Post by Flights of Fancy » 12 Oct 2009 19:07

One approach is to DCA into annuities over time. There are also some calculators here which (although limited) may be of interest:

http://www.qwema.ca/calc.htm

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Post by Spidey » 13 Oct 2009 08:28

bones1 wrote:
Spidey wrote:I don't know if those rates are linked to inflation. If not, it seems to me that a bank perpetual preferred, currently yielding almost 6%, would be a better bet.
Yes, but preferreds are equities. And bank preferreds are non-cumulative. So, the bank can stop paying dividends on them (as long as they do the same for the common shares) anytime they want, and if/when they resume dividends they don't owe you a cent in back-pay. And then there's the situation they could go bankrupt and leave the holder with nothing, much like the Nortel preferred shares.

I'm not sure that someone looking for the safety of an annuity should be messing around with equities.
Are the annuities covered by deposit insurance? If not, what happens if an insurance company runs into serious financial difficulty? Wouldn't the risk of this happening be somewhat similar to that of a major bank defaulting on their preferreds?
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Post by Shakespeare » 13 Oct 2009 08:51

Are the annuities covered by deposit insurance?
Assuris

http://www.assuris.ca/Client/Assuris/As ... ut+Annuity
If your life insurance company fails, your Payout Annuity policy will be transferred to a solvent company.

* On transfer, Assuris guarantees that you will retain up to $2,000 per month or 85% of the promised Monthly Income benefit, whichever is higher.
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Post by marty123 » 13 Oct 2009 11:39

Shakespeare wrote:
Are the annuities covered by deposit insurance?
Assuris

http://www.assuris.ca/Client/Assuris/As ... ut+Annuity
If your life insurance company fails, your Payout Annuity policy will be transferred to a solvent company.

* On transfer, Assuris guarantees that you will retain up to $2,000 per month or 85% of the promised Monthly Income benefit, whichever is higher.
But Assuris is not backed-up by the government. We're not talking about CDIC-level protection. Let's face it, if one or two large companies fail (say Manulife and/or Sunlife), there may be no way for this guarantee to be honoured.

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Post by Shakespeare » 13 Oct 2009 12:10

But Assuris is not backed-up by the government. We're not talking about CDIC-level protection. Let's face it, if one or two large companies fail (say Manulife and/or Sunlife), there may be no way for this guarantee to be honoured.
Why should everything be backed by the government?

Anyway, it behooves the annuity purchaser to select his insurance company with some care.
“A wise man should be prepared to abandon his baggage at any time.” -- R.A. Heinlein, The Door Into Summer.

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Post by marty123 » 13 Oct 2009 12:27

Shakespeare wrote:Why should everything be backed by the government?
I don't think it should be. Spidey used the phrase "deposit insurance" in his question. I thought it was important to make sure it's understood that we're not talking the type of guarantee provided by CDIC for deposit insurance.

It's important to understand that Assuris can pay out only if a small portion of the insurance market collapses. If several insurers fail, or if one or two big ones go bankrupt, annuitants will be out of luck.

Think of it as having automotive insurance that can only afford to pay for a few fender-benders, but that will become insolvent if anyone submits a claim for a totaled vehicle or a large liability claim.
Anyway, it behooves the annuity purchaser to select his insurance company with some care.
Exactly! And it should include diversification as well.

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Post by scomac » 13 Oct 2009 12:56

marty123 wrote: Exactly! And it should include diversification as well.
Could be tough for those with limited resources. Has anyone attempted to quantify the cost of diversification? In essence, it's insurance on insurance in this case, is it not?
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Post by kcowan » 13 Oct 2009 16:51

scomac wrote:
marty123 wrote:Exactly! And it should include diversification as well.
Could be tough for those with limited resources. Has anyone attempted to quantify the cost of diversification? In essence, it's insurance on insurance in this case, is it not?
Yes and as with insurance of any kind, including diversification, it comes with reduced yield.
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Post by Spidey » 13 Oct 2009 19:45

So does this mean that the consensus is that annuities are safer then preferred bank shares? During the last downturn, it seemed that the insurance companies, with their market-linked products were looking even more damaged then the banks. So I'm wondering, if the economy tanked to the point where banks were reneging on their preferred dividend payments, wouldn't it also be possible that a couple of big insurance companies also struggled with their commitments? Could Assuris cover the losses if a couple of big insurance companies started defaulting on their obligations?

(Perhaps stupid questions, but I don't know the answers.)
If life seems jolly rotten, then there's something you've forgotten -- and that's to laugh and smile and dance and sing. - Eric Idle

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Post by scomac » 13 Oct 2009 20:11

The commitment to the annuitant is quite a bit more senior to the commitment to a preferred share holder. In terms of priority of commitment, the annuitant would be ranked similar to a depositor at a bank.
"On what principle is it, that when we see nothing but improvement behind us, we are to expect nothing but deterioration before us?"
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Post by DenisD » 13 Oct 2009 22:13

marty123 wrote:But Assuris is not backed-up by the government. We're not talking about CDIC-level protection. Let's face it, if one or two large companies fail (say Manulife and/or Sunlife), there may be no way for this guarantee to be honoured.
If/when I buy an annuity, I'll be depending on the government to bail out any large insurance companies that fail. The bailout would enable the insurance company to meet its obligations to voters annuitants.

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Post by Shakespeare » 13 Oct 2009 22:16

If/when I buy an annuity, I'll be depending on the government to bail out any large insurance companies that fail.
There are two different approaches:

1. Use an insurance company small enough that Assuris can cover its failure.

2. Use an insurance company large enough that the government will.

:roll:
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Post by kcowan » 14 Oct 2009 11:05

Before seriously considering the purchase of any annuity, you might be wise to include The windup of Confederation Life as a part of your due diligence. It was the fourth largest at the time in 1994. Manulife bought the assets at the time. Crown Life took over administration of the annuities. Others took over their business outside Canada.

Real estate investments are rumoured to have contributed to their demise.
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Re: Annuities

Post by ghariton » 16 Nov 2010 01:44

Since I plan on annuitizing some of my money around 75 or so, I thought I would read a bit on the subject. The first book on my pile is Edward Cannon and Ian Tonks, Annuity Markets.

The book has a good overview of how annuities work, analyzing the demand for annuities and their supply, for a number of kinds of annuities (I didn't know there were so many). They include background detail, such as how to build a life expectancy table and how to value an annuity. They also spend some time on selection bias and adverse selection (not the same thing).

Their main tool is "money's worth", defined as the ratio of the present value of expected payments to the price of the annuity. When money's worth is around one, the customer is getting a good deal. The further below one, the worse the deal -- think of the difference between one and money's worth as the MER, although the analogy is not quite exact.

The authors show money's worth for a variety of types of annuity, countries, male/female, etc. The bulk of the data is for the U.K., which has the world's most developed annuity market, but there are some results for a variety of countries, including a few for Canada.

The main conclusion is that plain vanilla annuities (fixed level, no guarantee, not joint) are generally a fair deal for the buyer. In Canada, the money's worth is about 0.98, with similar values for the U.S., U.K., Australia. But more complicated annuities have lower money's worth.

The type of annuity I'm interested in, inflation indexed annuities, do particularly badly, with money's worth of about 0.88 for most countries. Significantly, there was not enough (public) data for Canada to calculate money's worth for inflation-indexed annuities, and I suspect that the value is even lower in such a thin market.

Of course, the annuity seller takes on inflation risk when selling an indexed annuity, and this has a price. It seems to be an increase in the MER of about 0.10, or 10%. But I'm sure that only part of that is the cost of risk -- the rest is exploiting a relatively thin market.

Two assumptions are worth noting. First, the calculations use life tables drawn up to reflect annuitants' life experiences. Annuitants on average live longer than the general population. If one were to use the general population's life expectancies in calculating lifre expectancies, money's worth drops by about 0.05. So a purchaser of an annuity had better think he or she is relatively long-lived, i.e. similar to the annuitant population rather than the general population.

Second, the return on investment (and so the discount rate used to value future benefits) is the return on government bonds. If return on corporate bonds or on equities is used, the money's worth drops again. So if a potential annuitant is willing to take on equity risk, again an annuity is not such a good deal.

The authors spend about half the book examining the "annuity puzzle", i.e. why in practice fewer people annuitize than theory would predict, and why those who do, annuitize less of their net wealth than theory would predict. The evidence seems to reject the usual explanations and they are driven to behavioural finance:

-- Prospect theory and loss aversion -- a significant concern that a purchaser might die before getting his oir her money back; people overestimate their probability of dying soon after purchase, and underestimate their probability of outliving their money

-- Framing effects -- including the way the benefits of an annuity are presented (in a table versus a graph), the number of choices available, and so on.

While both of these have an impact empirically, the impact is not big enough to solve the annuity puzzle. The authors resort to a final factor: people are just not well enough informed about annuities. In the U.K., the FSA has estimated that only about half of the population with a private pension and on the verge of having to convert it, had a reasonable knowledge of annuities.

Drawbacks:

(1) Heavy on U.K. data; one wonders if the findings are transferable to Canada

(2) The book was published in December 2008: is it out of date already?

The book has some calculus, but a reader can skip it with no great loss. Its main function is to show that the results are sensitive to changes in assumptions, and we already know that.

George
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