Ok.
The SPIA has NO capability of reversal. There ought to be a large illiquidity premium.
The SPIA will keep my principal if I die early. The contracts are designed in such a way by the actuaries that the vast majority of annuitants will benefit the insurance company, not themselves. There ought to be an early death risk premium.
The SPIA issuer may default and cause me serious delays in cashflow. A risk premium ought to be added.
Ignoring inflation, since we'll compare the returns to a theoretical 30-year treasury, we have a framework.
How might you value these drawbacks? Are they worth 1% per year? 2%? More? We would presume the annuity could offer us at least 1% more return per year than a comparable 30-year treasury--one hopes.
The 30-year treasury, with an inverted yield curve, currently provides 4.33% return.
https://www.cnbc.com/quotes/US30Y
This return will occur, regardless of whether I die. If my heirs inherit it, they will get the 4.33% for the remainder of the 30-year period. Not so with a SPIA. The actuaries currently calculate I'll die around 73.
https://www.verywellhealth.com/how-to-l ... en-2223908
A 70-year-old can expect to live until about age 85
https://money.usnews.com/money/retireme ... expectancy
Thus, if I'm 70 and buy the product, (the age at which many a salesperson says the SPIA is most "valuable") the annuity company is more than happy to provide me plenty of my premium back and mislabel it a return. They know that they are highly likely to keep most of my money. Today, if I buy a SPIA and I were 70 years old with $500,000 to invest, the most generous SPIA provides a monthly cashflow of...
$3,549.68/month
Presuming there are no other fees, commissions, surcharges, transaction fees, etc, it will take me until age 81 to begin earning a single penny of a return. Let's presume I die at the average age of 73. My return is about -75%. Talk about a "safe" product. But what if I live a nice long life to age 85? My return will be...3.7%. Well below our 4.33% threshold for the treasury. I have to live an extremely long life to age 90, to get a whopping 6.2% average rate of return.
Thus, we see how annuities are sold to investors with a particularly deceptive combination of fear and hope:
Fear: You will outlive your money and the markets will be too volatile and you won't be able to generate enough of a return
Hope: You're going to live a well above-average lifespan. Don't worry about actuarial calculations--you're special!
So then why wouldn't I just buy an annuity at age 40? Two reasons:
1) I'm not afraid of death yet so I have more risk tolerance and know that a) inflation will eat my lunch over that long period and b) I can get a way better return in the stock market with my higher risk tolerance.
2) The actuaries already account for that, so my payment drops to $2,389.88/month, which takes me until about age 60 before I can start earning any return on my investment. If I happen to make it the full 30 years, I'll earn a 4.1% return, still below the 30-year treasury rate of 4.33%.
I will have sacrificed all that liquidity, the higher default risk, the early death risk...for a lower return over the same period.
When one has the stamina to compare apples to apples, annuities come up short, every time.
The SPIA has NO capability of reversal. There ought to be a large illiquidity premium.
The SPIA will keep my principal if I die early. The contracts are designed in such a way by the actuaries that the vast majority of annuitants will benefit the insurance company, not themselves. There ought to be an early death risk premium.
The SPIA issuer may default and cause me serious delays in cashflow. A risk premium ought to be added.
Ignoring inflation, since we'll compare the returns to a theoretical 30-year treasury, we have a framework.
How might you value these drawbacks? Are they worth 1% per year? 2%? More? We would presume the annuity could offer us at least 1% more return per year than a comparable 30-year treasury--one hopes.
The 30-year treasury, with an inverted yield curve, currently provides 4.33% return.
https://www.cnbc.com/quotes/US30Y
This return will occur, regardless of whether I die. If my heirs inherit it, they will get the 4.33% for the remainder of the 30-year period. Not so with a SPIA. The actuaries currently calculate I'll die around 73.
https://www.verywellhealth.com/how-to-l ... en-2223908
A 70-year-old can expect to live until about age 85
https://money.usnews.com/money/retireme ... expectancy
Thus, if I'm 70 and buy the product, (the age at which many a salesperson says the SPIA is most "valuable") the annuity company is more than happy to provide me plenty of my premium back and mislabel it a return. They know that they are highly likely to keep most of my money. Today, if I buy a SPIA and I were 70 years old with $500,000 to invest, the most generous SPIA provides a monthly cashflow of...
$3,549.68/month
Presuming there are no other fees, commissions, surcharges, transaction fees, etc, it will take me until age 81 to begin earning a single penny of a return. Let's presume I die at the average age of 73. My return is about -75%. Talk about a "safe" product. But what if I live a nice long life to age 85? My return will be...3.7%. Well below our 4.33% threshold for the treasury. I have to live an extremely long life to age 90, to get a whopping 6.2% average rate of return.
Thus, we see how annuities are sold to investors with a particularly deceptive combination of fear and hope:
Fear: You will outlive your money and the markets will be too volatile and you won't be able to generate enough of a return
Hope: You're going to live a well above-average lifespan. Don't worry about actuarial calculations--you're special!
So then why wouldn't I just buy an annuity at age 40? Two reasons:
1) I'm not afraid of death yet so I have more risk tolerance and know that a) inflation will eat my lunch over that long period and b) I can get a way better return in the stock market with my higher risk tolerance.
2) The actuaries already account for that, so my payment drops to $2,389.88/month, which takes me until about age 60 before I can start earning any return on my investment. If I happen to make it the full 30 years, I'll earn a 4.1% return, still below the 30-year treasury rate of 4.33%.
I will have sacrificed all that liquidity, the higher default risk, the early death risk...for a lower return over the same period.
When one has the stamina to compare apples to apples, annuities come up short, every time.
Statistics: Posted by DesertFarmer — Sun Jul 14, 2024 4:28 am — Replies 5 — Views 848