We got the following question from a prospective advisor today that illustrates a very common scenario.
We have a potential client that is looking at purchasing $1.1M immediate Annuity.
In October 2014 he will be 69 and she will be 63.
The immediate annuity they are looking at will pay them a 4.7% payout factor starting when he’s 69 with a 1% increase per year for both of their lives. Its IRA $.
Is there any other products that you think could beat that with payout factors and increases???
Here’s how we addressed the situation with Secondary Market Annuities-
The primary benefit of an immediate annuity is the lifetime income/ longevity protection. If that is a value driver for the client, stick with the immediate annuity.
However, to compare apples to apples, take a moment to look at the math. A 4.7% payout factor on $1.1M investment starts at roughly $4300/ month. Add in the 1% increase per year and assume mortality in 30 years, which is around 36% probability per the annuity 2000 mortality tables.
When you put this into the calculator, it returns an effective rate of return of 3.428%
Incidentally, if you want to check any actuarial scenario yourself, here is a nifty excel based actuarial calculator:
And here’s a good web based discounted math calculator.
Compare to Secondary Market Annuities
For comparison purposes, I illustrated a $1.1M investment in a 30 year income stream (Takes it to the wife’s age 93) with a 1% COLA and an assumed effective rate of return of 5.25%, which is at or below where we’d be for this sort of income stream. Solving for payout, the SMA solution is close to $5400/mo.
To attain even a 5% rate of return on the SPIA, these clients would need to collect 600 monthly payments! 50 years!
So right away, the SMA offers more income, but at the expense of longevity protection. But is the longevity protection even needed?
This is where knowing client needs plays in- smoker? Health issues? Family history or early mortality? If so, with an immediate annuity they are basically locking in today’s low rates until ell after their anticipated actuarial mortality, and don’t benefit from mortality credits (insurance) until the end of the contract.
If early mortality is a possibility, they’re effectively buying unneeded insurance. In these situations, I prefer to solve for a floor income amount, and let the client invest the difference. That investment + growth = inflation protection, flexibility, and liquidity.
Focus on Needs:
Lets say they really determined they needed $4500/ mo for 25 years (wife’s age 88). That would cost just $830K, leaving the clients with $275,000 savings to grow. This is their best inflation hedge and liquidity reserve.
Sound like I’m talking down a possible sale? No way- it’s much better for the clients to use annuities for just what they client needs, and not overdo it, than to oversell and leave clients without options.
Caveat- immediate income cases are in short supply, and the client would need to piece together 5 or 6 cases to attain this income stream. It would not be 1 and done like an immediate annuity. I wish there was a better way, but unfortunately, there is not.