Annuities

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

Post by longinvest »

His calculations don't take into account adverse selection among annuity buyers. Think about it: would a poor person who didn't take care of her health buy a SPIA? Statistics Canada's mortality tables include such a person. It makes sense for life annuity providers to use more conservative mortality tables. This means that the implied interest rate is higher than Michael James calculated.

I would be more interested to know the payout on a CPI-indexed life annuity.
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Re: Annuities

Post by brucecohen »

I don't understand what James did and the StatCan life table he links to is a summary that does not include a 70-year-old male.

I used the detailed 2007-09 StatCan table. Average life expectancy for the 70-year-old male cohort is 14.67 years (age 85) and there's a 25% chance of passing age 90.

So, assuming present value of $313,820 per James, what's the discount rate required to fund $2,000/month for 15 years and for 20 years?
-- 15 years: just about 1.9% (PV=$313,890.43)
-- 20 years: just about 4.73% (PV=$313,846.68)

Note that this is a "pure" calculation with no provision for marketing, administration and investment management costs.
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Re: Annuities

Post by Springbok »

brucecohen wrote: So, assuming present value of $313,820 per James, what's the discount rate required to fund $2,000/month for 15 years and for 20 years?
-- 15 years: just about 1.9% (PV=$313,890.43)
-- 20 years: just about 4.73% (PV=$313,846.68)
I may not have understood correctly, but I don't think that is what he calculated.
To do this, I worked out what interest rate the insurance company would have to make to exactly cover all the payments to a large group of people who buy the same annuity. For that I needed actuarial tables that predict how many people will live to each age. I used data from Statistics Canada. Note that this is not the same as just using average life expectancy; I actually assume the insurance company keeps making payments to remaining survivors each year.
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Re: Annuities

Post by brucecohen »

Springbok wrote: I may not have understood correctly, but I don't think that is what he calculated.
To do this, I worked out what interest rate the insurance company would have to make to exactly cover all the payments to a large group of people who buy the same annuity. For that I needed actuarial tables that predict how many people will live to each age. I used data from Statistics Canada. Note that this is not the same as just using average life expectancy; I actually assume the insurance company keeps making payments to remaining survivors each year.
That's not what he calculated. But I'm not clear on what he did calculate. Here is the detailed Stat Can table he probably used. Out of a 100,000-member cohort it projects that 80,301 will be alive at 70, 78,663 at 71 etc. I think he assumed that every one of the 80,301 put in $313,000+ and started receiving $2,000/month. The capital of those who died in year 1 remained in the fund and subsidized payments to those still living. There are several problems with this:
-- As already noted, StatCan's projections cover the entire population which includes poor and sick people who tend to die early and thus would not be likely to buy a life annuity
-- Many people who do buy annuities buy guarantees running 5 to 15 years. He did not provide for that.
-- His analysis assumes the issuer faces no cost in marketing, administering and managing the pool

James offers no practical insight. The only inference from his analysis is that insurers can probably make a lot of money on life annuities. But that's already well known and it's why the insurance industry has so vigorously and successfully fought to protect its monopoly.

The only relevant issue is what a DIY income stream would have to earn to match the insurer's payout. That's what my calc tells you. If you're 70, have $314,000 or so and want to draw $2,000/month till age 90 your investments must average 4.73% net of MER. (The insurer can earn less because it can use mortality credits from those who die early; you can't.) If you're more conservative, push the terminal age to 95. You have an 8% chance of being alive then. To fund 25 years of payments you need to average 6.1% -- and pray that you don't suffer a big market loss in the early years. Of course, you still face the longevity risk of living past 95. James doesn't appear to understand that there's an average life expectancy for every aged cohort. The ALE is the point at which half the cohort members are expected to be dead. So at each age you have a 50% chance of outliving the ALE for your cohort.
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Re: Annuities

Post by Springbok »

brucecohen wrote: James offers no practical insight. The only inference from his analysis is that insurers can probably make a lot of money on life annuities. But that's already well known and it's why the insurance industry has so vigorously and successfully fought to protect its monopoly.
You should let him know. I think you can respond right onhis blog site.
brucecohen wrote:The only relevant issue is what a DIY income stream would have to earn to match the insurer's payout. That's what my calc tells you. If you're 70, have $314,000 or so and want to draw $2,000/month till age 90 your investments must average 4.73% net of MER. hort.
I had obtained out approx same numbers using Gummy's calculator. Problem is, where to find stable investments that will pay 4.73% after expenses over a 20 yr period. Possibly preferred shares or some corporate bonds/debentures might. You may or may not have all of your capital at end, but you should have most of it. Unlikely it would be zero, as in the case of the annuity. If you invest in GICs or HISAs or gov bonds, you may be better to go with the annuity.
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Re: Annuities

Post by brucecohen »

Springbok wrote:You may or may not have all of your capital at end, but you should have most of it. Unlikely it would be zero, as in the case of the annuity.
You'll end up with most of your capital only if you die early or generate unusually good investment returns. The 4.73% calc requires capital drawdown to fund the desired income stream. In the 20-year case above (age 70 to 90) payouts totaled $480,000 and by design exhausted the account. Interest funded $166,153.32 or 35% of the total. RoC funded 65%. Note that a 70-year-old man has a 1-in-4 chance of living past 90.

Note too that Interest generated falls each year as the capital base declines. In the first year interest totals $14,234.39. That's 59% of the $24,000 in payments received. In year 5 interest covers 51% of the payout stream. In year 10 it's 38%. In year 15 interest covers just 22% of the $24,000 pension. The account balance at the end of year 15 is $107,350.81. So in this scenario living to ALE exhausts about 2/3 of capital -- and, by definition, our individual has a 50% chance of outliving ALE.

It's also important to recognize that this scenario makes no provision for investment expenses or market losses. Suppose the account balance at the end of year-2 is down by 10%, a normal correction. The required return for the next 18 years -- net of expenses -- increases from the original 4.73%to about 6.2%. Remember that a purchased annuity provides immunity from market risk as well as longevity risk. Consider too that using corporate bonds and preferred bonds might well increase the risk of market loss due to the need to regularly draw capital in order to generate the required income. And there's the issue of liquidation efficiency. In year 1, for example, you need about $700/month in RoC. Bond trading is not retail-friendly/efficient. ETFs would probably be the vehicle of choice, but you then have to increase the desired monthly income by enough to cover the commission(s).

BTW, there's another problem with the James article. There's no indication of how the RBC quote he used compared to offerings by other issuers. For various reasons sometimes an insurer doesn't really want to sell any more annuities for a while. But it doesn't shut the window. It just offers lousy pricing. Here are top quotes at Jan 6. RBC isn't on the list and the best quote (Sun Life) is 9% better than the worst (BMO Life). While there's no way to tell if/how rates changed between Jan 6 and James' calc, someone putting $313,820 into a Sun Life annuity would get $2,209/month -- 10.4% more than James got from RBC.
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Re: Annuities

Post by Springbok »

Bruce,
Regarding your first paragraph, roc is only required if you assume a very low yield. Any balanced fund should yield total return of 6-8%. Even preferreds should do better than the 4.7%. But if you want security you might use gics. But then perhaps you may want to be safer still and buy the annuity. Different strokes.

Mind you, this is like saying a 7.6% rule will work when some question the 4% SWR. So I am no doubt wrong :oops:

We have drawn 3.5-4.5% pa from our DIY annuity for past 12 years and nest egg has grown by 50% despite the recession. I have not attempted to work out what we now would have if we had withdrawn the 7.65% that the annuity would distribute.
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Re: Annuities

Post by Ken »

Having never looked at annuities until yesterday because I saw this thread, I Googled it and found RBC has an "annuity calculator" for if you choose to buy a life annuity from RBC. $1,000,000 given to them for 25 years generates about $4000 per month. If instead I simply spend that $1,000,000 over 25 years, with zero income from it, I can spend about $3300 per month. LOL. Based on that, I won't be shopping for an annuity anytime soon.
So a question... I read some (not all) back posts on this thread but did not see any mention of where you folks shop for annuities.
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Re: Annuities

Post by AltaRed »

Ken wrote:Having never looked at annuities until yesterday because I saw this thread, I Googled it and found RBC has an "annuity calculator" for if you choose to buy a life annuity from RBC. $1,000,000 given to them for 25 years generates about $4000 per month. If instead I simply spend that $1,000,000 over 25 years, with zero income from it, I can spend about $3300 per month.
Life annuity and a 25 year payment stream are inconsistent. What if you continue to live and collect for 40 years?

Added: As an example, my mother collected annuity payments for 35 (maybe 36) years on a small annuity she had before she died.
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Re: Annuities

Post by CROCKD »

Ken wrote:did not see any mention of where you folks shop for annuities.
My impression is that most active members of FWF do not shop for annuities because they consider them an inferior financial product.
However if you want to consider what various insurance companies are offering you might want to take a look at this site.
Life Annuities
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Re: Annuities

Post by Ken »

AltaRed wrote:Life annuity and a 25 year payment stream are inconsistent. What if you continue to live and collect for 40 years?
Agreed, but their calculator allows a maximum of 25 years
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Re: Annuities

Post by longinvest »

CROCKD provided an interesting link! So, according to http://www.lifeannuities.com/annuity-ra ... joint.html, a 65 year-old couple could have bought a joint life annuity, indexed 2% per year, with a 4.67% payout in January 2014 ($389.51 X 12 / $100,000).

I guess that a CPI-indexed one would have been around 4%; not too bad, except for losing the capital forever :evil: . It could be a useful tool to guarantee a base lifelong retirement income floor unaffected by markets, if CPP and OAS are insufficient. (No guarantee is absolute: the government could cut OAS, Assuris could default on its guarantees, etc.).
Last edited by longinvest on 23 May 2015 13:06, edited 2 times in total.
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Re: Annuities

Post by Ken »

CROCKD wrote:My impression is that most active members of FWF do not shop for annuities because they consider them an inferior financial product.
I'll agree with that. I assume that the great unwashed likes them because they don't have to think about anything after buying it.
CROCKD wrote:However if you want to consider what various insurance companies are offering you might want to take a look at this site.
Life Annuities
Thanks! Their calculator is useless unless you give them your personal info (no spam for me thanks). But their "Annuity Rates" tab, showing 2014 rates from various insurance companies is interesting and shows somewhat better monthly income values than the 2015 numbers I got from RBC.

But that's enough of that. I think I'm done looking at annuities. :)
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Re: Annuities

Post by adrian2 »

Springbok wrote:Any balanced fund should yield total return of 6-8%. Even preferreds should do better than the 4.7%.
Wrong!
Springbok wrote:Mind you, this is like saying a 7.6% rule will work when some question the 4% SWR. So I am no doubt wrong :oops:
Yes, you are wrong!
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Re: Annuities

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Ken wrote: I assume that the great unwashed likes them because they don't have to think about anything after buying it.
I think that is unfair. It is like, in most cases, an indexed DB pension where people want either: 1) certainty of a certain income no matter how long they live, or 2) know they run the risk of running out of money particularly if there is a lack of confidence in financial markets or financial advisors. I would perceive it to be more of a vulnerable feeling IF the portfolio is fairly small. There is even rationale for those with no DB pension to want to lock in a certain minimum income to pay for a good portion of the rent and food.
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Re: Annuities

Post by AltaRed »

adrian2 wrote:Yes, you are wrong!
I see it more as a hang up around preservation of capital, i.e. leaving a legacy seems to be way more important to some folk than most. Hence the strong desire to have income cover an upper middle class lifestyle with minimal tapping of capital (indeed capital seems to have grown).

While I am pretty certain I will be leaving a legacy as well, it does not factor into my plans. I worked hard for it and supported and raised my children to be successful, graduating from university with no debt. They need nothing more from me to succeed on their own.
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Re: Annuities

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AltaRed wrote:
While I am pretty certain I will be leaving a legacy as well, it does not factor into my plans. I worked hard for it and supported and raised my children to be successful, graduating from university with no debt. They need nothing more from me to succeed on their own.
This is a reasonable approach and you have also mentioned that you have also helped your kids with occasional cash gifts.
I am still working my way through this issue and like you have equipped my daughter with what she needs to succeed. It just seems difficult to end up with the portfolio near zero? Most of us here are pretty risk averse, so that nagging question of how long we last and how expensive the last years might be, get in the way of running the portfolio down to zero, or close to it. I suspect most of us will leave pretty sizeable estates, whether we wish to or not.
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Re: Annuities

Post by AltaRed »

SQRT wrote:It just seems difficult to end up with the portfolio near zero? Most of us here are pretty risk averse, so that nagging question of how long we last and how expensive the last years might be, get in the way of running the portfolio down to zero, or close to it. I suspect most of us will leave pretty sizeable estates, whether we wish to or not.
Nor should those of us who have the capacity in portfolio size take an outsize risk of running close to empty by, for example, age 95. But it also makes no sense to not tap capital over a 30 year withdrawal period. Spending only the income stream could easily result in existing equity capital tripling from capital appreciation alone over 30 years. That is pretty obscene in my books.
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Re: Annuities

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AltaRed wrote:
SQRT wrote:It just seems difficult to end up with the portfolio near zero? Most of us here are pretty risk averse, so that nagging question of how long we last and how expensive the last years might be, get in the way of running the portfolio down to zero, or close to it. I suspect most of us will leave pretty sizeable estates, whether we wish to or not.
Nor should those of us who have the capacity in portfolio size take an outsize risk of running close to empty by, for example, age 95. But it also makes no sense to not tap capital over a 30 year withdrawal period. Spending only the income stream could easily result in existing equity capital tripling from capital appreciation alone over 30 years. That is pretty obscene in my books.
Agree. Could easily triple or much more. Even at 5% growth it would increase by over 4 times in 30 years. My spouse could easily live another 35 years so that would make it 5 times. This would leave much too much, much too late. Not sure about the term "obscene" but I get your point. Sub optimal for sure.
My inlaws always spent less than their portfolio allowed and have been very "frugal" shall I say. We have encouraged them to spend more on themselves, but that train has left the station. They are in their late eighties. Their estate will be quite large as a result. I hope to avoid this result, somehow.
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Re: Annuities

Post by longinvest »

Delaying CPP and OAS is one way to buy a cheap CPI-indexed life annuity and allows one to spend more in earlier retirement years without increasing the risk of ruin.

Of course, when one does a break-even analysis assuming a reasonable rate of return, the break-even age is very high (over 90 and could even go over 100, depending on assumptions). But, that's not the point. The point is to allow one to spend more without risk of ruin regardless of longevity.

Delaying OAS by 5 years increases the annual pension from $6.5K to $9K. That's a cost of $35K (5 X $6.5K + growth) for a $2.5K pension ($9K - $6.5K), or a 7.14% CPI-indexed payout for a 70+ year-old (unisex). That's really cheap when compared to the current non-indexed 7.65% payout for a 70 years-old male on the market (Globe Investor annuity rates). For females, the deal is even sweeter; the annuity market non-indexed payout is 6.66%, lower than OAS's indexed payout!
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Re: Annuities

Post by longinvest »

The easy way to "buy" OAS and CPP "additional annuity" is to use good old GICs.

Here's how I would buy a delayed OAS additional annuity:

I would put $9K in a savings account and $9K, each, in 1, 2, 3, and 4-year GICs (shopping for the highest rates).

Of this $45K (5 X $9K), $32.5K (9 X $6.5K) represents the premium to buy an additional $2.5K OAS annuity at 70+. The remaining $12.5K represents the additional money I can immediately spend as an annual GIC-rate-indexed $2.5K.

The same could be done with CPP, delaying 10 years from 60 to 70.

It's not a whole lot of additional yearly money. If you had kept the $45K in your portfolio spending 4% per year, it would have translated into an annual $1.8K (with risk of ruin). Delaying OAS gives you an annual $2.5K (no risk of ruin). That's only a modest (but robust!) additional $700 per year, but why leave the money on the table?

For those only spending the dividends on a fund such as XIC (2.54%), that would translate into an additional $1357 per year (instead of $700) in earlier retirement years.
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Re: Annuities

Post by longinvest »

Here's another way to look at it.

If we consider that the implied price of the additional annuity bought by delaying OAS is a fair price, it would mean that the prices of annuities marketed by insurance companies are hugely inflated, considering their lower credit rating. That would easily explain the general aversion (on this forum and elsewhere) to buy these life annuities.
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Re: Annuities

Post by Ken »

Regarding delayed CPP and/or OAS... My opinion FWIW is if the gov't is willing to give you money then take it. Take it now.
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Re: Annuities

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Ken wrote:Regarding delayed CPP and/or OAS... My opinion FWIW is if the gov't is willing to give you money then take it. Take it now.
If I had bequest motives, I would fully agree with you.

If not and I decided to keep $45K in my stock portfolio spending the 2.54% dividends per year, and elected to receive $6.5K OAS, I would be spending less in my earlier retirement years, when each dollar is usually more valuable (I'm healthier, etc.). Delaying OAS would let me spend more! That was my whole point.

You could consider political risk. Yet, most governments cut entitlements of future retirees, not active ones. It can be politically suicidal for a government to cut the entitlements of the most politically-active voter base (retirees).
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Re: Annuities

Post by like_to_retire »

longinvest wrote:Delaying CPP and OAS is one way to buy a cheap CPI-indexed life annuity and allows one to spend more in earlier retirement years without increasing the risk of ruin.
I suppose if you were at or near clawback, then the increased OAS income in 5 years may increase clawback at that time. That may be a negative.

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