100% Guaranteed Income Forever? Bond Ladder vs Single Premium Immediate Annuity

How long will you live & how can annuities help reduce longevity risk? What exactly is a single premium immediate annuity (SPIA), how does it work & is it better for you than a bond ladder? Email jennifer@diamondnestegg.com & we will connect you with a colleague who will create your customized annuity plan for you.

Transcript

SPEAKER_00 0:00

Guaranteed lifetime income from a single premium immediate annuity. Is this better than a treasury or bond ladder? Hello, Diamond Estic Members, Super Savers and Course fans, I hope you're healthy and well. As more and more of the retirees and soon-to-be retirees in our community are exploring additional sources of guaranteed lifetime income to supplement Social Security, and especially during uncertain market times like the one we're currently living in, one of the most frequently asked questions you've sent our way recently is this How does a single premium immediate annuity or SPIA compare to a bond ladder? So, with that in mind, here are the three topics I'll be covering today. One, how long might you live and how can annuities help reduce longevity risk? Two, what is a single premium immediate annuity or SPIA? And how does it work? And three, is a SPIA better for you than a treasury or bond ladder? For all the number lovers in our Diamond Neste community, you will love the numbers we'll be comparing in this section of today's video. Let's dive in now, folks. How long might you live and how can annuities help reduce longevity risk? According to the Social Security Administration's latest actuarial life table, this is what our life expectancy looks like. This column shows your exact age. For example, your current age. And these columns show how long you're expected to live from this age for both men and women. So if you're exactly 60 years old right now and a male, you can expect to live until you're 81.1 years old on average. And the good news is that life expectancy has gone up. These 81.1 years are higher than the 80.4 years for 60-year-old male in the Social Security Administration's previous table from a year ago. And if you're 60 right now and a female, you can expect to live until you're 84.1 years old on average. And good news again, as these 84.1 years are also higher than the 83.7 years for 60-year-old female in the Social Security Administration's previous table from a year ago. So let's hope that all of us will be living just a bit longer. Here's what the life expectancy numbers look like through age 69. And here's what the life expectancy numbers look like through age 79. And here's what the life expectancy numbers look like through age 89. Remember that the life expectancy numbers here are averages, and that no one can tell you with certainty whether your personal life expectancy will be like these averages here, or whether it will be shorter or longer. So, while living longer is great on most levels, planning for longevity is no easy task, financially speaking, especially when you have to factor in inflation, market downturns, health care, housing costs, and so on. No one wants to run out of money in their last years of life. And that's where the flooring strategy comes in when you plan for retirement. It will help reduce this longevity risk. Or in other words, the flooring strategy means that all your essential living expenses should be covered in total by income streams that are guaranteed for life. Here's an illustration of how the flooring strategy works. On this side, you have your essential living expenses, which include all your basic out-of-pocket costs. And on this side, you have your guaranteed lifetime income streams. There are really three potential sources for an income that is guaranteed to last as long as you live. The first guaranteed lifetime income stream is Social Security, which most of us should receive, assuming that we've worked and paid Social Security taxes for at least 10 years or earned 40 credits. A second guaranteed lifetime income stream could come from a company pension. Company pensions are rare these days, but I know that some of the folks in our Diamond Neste community are lucky enough to have one. And a third guaranteed lifetime income stream can come from annuities. Annuities are the only source of a guaranteed lifetime income stream that you can create and design according to your personal needs. This is not something you can really do with Social Security or a corporate pension from your employer. When you add up these three sources of guaranteed lifetime income, the combined monthly checks you will get for life, you create this floor here, this minimum level of regular income that you should receive for the rest of your life, and which should ideally cover all your essential living expenses here, no matter how long you live. Bondmasters, folks, please refer back to module 7, the decumulation phase, video G for more details on the flooring strategy. So, annuities. Think of annuities as a way for savers like you and me to create our own private or personal pension, a way to give ourselves another steady guaranteed paycheck every month for the rest of our life, on top of Social Security and our company pension, if we have one, so that we can cover our essential living expenses, or perhaps even so that we can cover the finer extra things in life for as long as we live. Now that you understand annuities and the flooring strategy on a high level, let's move on to the next section of today's discussion. What is a single premium immediate annuity or SPIA? And how does it work? On the most fundamental level, an annuity is a financial contract between you and an insurance company. There are two basic types of income annuities. The first type are tax-deferred annuities, which typically allow you to accumulate tax-deferred savings while providing you the option to create lifetime income in the future. Tax-deferred annuities have two primary parts, the accumulation phase and the payout phase. During the accumulation phase, you pay into the annuity and your money grows tax deferred, like a savings plan, allowing your funds to grow more quickly. The payout phase begins when you start receiving annuity payments, which can be set to a certain number of years only or for the rest of your life. In some instances, you may be able to choose a quarterly or annual payment frequency. But monthly payouts are the most common choice. The second type of annuities are immediate annuities, which skip the savings phase, the accumulation phase, and jump directly into the payout phase, so to speak. And they generally offer a monthly payout for life in return for a lump sum investment. So, as I mentioned before, in today's video we're going to focus primarily on lifelong immediate income annuities, and specifically on a type of income annuity that is often referred to in the industry as a single premium immediate annuity or SPIA, as this appears to be what many in our Diamond Neste community have recently purchased or are currently interested in learning more about. So here's an illustration of how a single premium immediate annuity or SPIA works. On day one, you make a single upfront payment to the insurance company. This single upfront payment is typically a large amount of money and the only payment that you will ever make to the insurance company, and is also why this type of annuity is referred to as single premium. You pay only once to buy the annuity, so to speak. And the immediate part here refers to the fact that immediately or very shortly after your payment, the insurance company begins to pay you a guaranteed monthly income for the rest of your life. There is a relatively short wait time before the checks start coming. As I touched upon before, in some instances you may be able to choose a quarterly or annual payout, but monthly payouts are the most common choice. As Marcus and I like to say, annuities come in many different flavors and can be customized in a number of ways to your personal situation. So if you're interested in what your personal rates and payouts might look like at the time you're watching this video, email us at jennifer at diamondnestic.com so that we can connect you with our trusted annuity specialists who can help pull together the latest numbers for your individual circumstances, goals, and expectations. And please remember again that today we're talking about annuities that provide a lifetime income stream only. So let's say that you're 67 and have$100,000 that you want to convert into a lifetime monthly income stream. One option is for you to buy a SPIA, and on day one, you make a single upfront payment to the insurance company of$100,000. And let's say that immediately or very shortly after a payment, say at the end of the month, the insurance company starts paying you a guaranteed monthly income of$600 for the rest of your life. Please note that the$600 per month is based on sample calculations for illustration purposes at the time of this taping and may change over time. Now, you may be wondering, is this single premium immediate annuity better for me or should I use my$100,000 to build a treasury or bond ladder? And the answer is it depends. So let's walk through what it depends on in the next section of this video. Is a SPIA better for you than a treasury or bond ladder? For a SPIA versus bond ladder comparison, we've made three key assumptions. First, you're 67 years old and you have$100,000 to invest, either into a single premium immediate annuity or into a bond ladder. Second, the SPIA would pay you$600 monthly or$7,200 annually for the rest of your life, no matter how long you live. Third, like the SPIA, the bond ladder would also pay you$600 monthly or$7,200 annually, with the payment comprising both interest earned at an average interest rate of 4.25% across all maturities and principal repayment whenever each rung of the bond ladder matures. Both the monthly SPIA payments and the average interest on the bond ladder of 4.25% are plausible assumptions at the time of this taping, but they may change over time. As I mentioned earlier, all the numbers that we're presenting today are for illustration purposes only. Your personal annuity rate and payout are not fixed until you sign your annuity contract. Please also note that we did not factor in taxes or inflation in our comparison. These are all nominal amounts before tax for both the SPIA and the bond ladder. Having said that, the return of principal will generally be tax free for both the SPIA and the maturing bonds in the ladder. Do consult with your tax advisor if you want to dig deeper into the tax aspects of anything discussed in today's video. So, back to our comparison. Before you build your bond ladder at the beginning of year one, you would already need to set aside$7,200 from your initial$100,000 to cover your year one expenses. Because for the sake of simplicity, plus the fact that it doesn't really change the big picture that much anyway, we have assumed that the interest payments and principal repayment from the first rung of your bond ladder will only become available at the end of year one to cover your year two expenses, meaning you're not immediately spending the first interest payment that comes in after six months. So that's this$7,200 here set aside for your year one expenses, leaving you with only$92,800 to invest in your bond ladder. And to cover your ongoing$7,200 of expenses in year two and beyond with your bond ladder, the same amount that you would have received annually had you purchased the SPIA here, here's an example of the bonds you would need to buy for your ladder. This column shows all the bonds that you would need to buy at the beginning of year one, 20 different bonds. And this column shows you which year's worth of expenses would be covered when this bond here matures. So this bond here would mature at the end of year one and would cover expenses in year two. This bond here would mature at the end of year two and would cover expenses in year three, and so on, until we get to this bond here, which would mature at the end of year 20 and would cover expenses in year 21, at least partially. This column shows the principal value of each bond that you would need to buy. This column shows the interest payment on the remaining bond ladder that you would receive. And this column shows your total annual payment, which in all years except the last one, which we'll talk about shortly, equals$7,200. Again, what we're trying to do here with the bond ladder is to recreate this payment of$7,200 annually that you would have received had you purchased the SPIA here. So in year one, you would receive$3,256 in principal repayment when this bond matures, and$3,944 in interest payments from your entire bond ladder. That's this interest rate of 4.25% multiplied by$92,800, the principal value of all these bonds here added together. And in year two, you would receive$3,394 in principal repayment when this bond matures, and$3,806 in interest payments from your remaining bond ladder. That's this interest rate of 4.25% multiplied by the principal value of all these remaining bonds here added together. But the interest payment is lower than before because remember, this one-year bond is now gone and the proceeds spent. And what we can see is that with every passing year, as more and more bonds mature, your total annual payment will be made up increasingly of principal repayment and less and less of the interest payments from the remaining bond ladder. And what you can also see is that you run out of money after year 20, because this 20-year bond here, when it matures, will not really cover your expenses for year 21. Having said that, if we look at this life expectancy table from before, if you have the average life expectancy of a 67-year-old, whether that's male or female, this bond ladder would have covered you because this bond ladder would give you your monthly$600 in payouts for a bit more than 20 years until shortly after you turn 87. And that's longer than the life expectancy for a 67-year-old, which currently stands at 83.1 years for a man and 85.6 years for a woman. And any remaining amounts would still be available to you if you live a few years longer, or they could go to your heirs or charities of choice. If you live more than a few years longer than the average life expectancy, though, and specifically past the point when this last bond matures, you will run out of money. Because this final rung of your bond ladder, this is all the principal that you will have left from your initial$100,000 investment after 20 years. And this principal amount and the interest earned on it, this last annual payment here, it's significantly lower than in all these other years prior and won't fully cover your essential expenses for a full 12 months. And that's where lifelong annuities are different, like the single premium immediate annuity example we're discussing here, because they help manage longevity risk. Yes, some folks think of annuities as investment products, and certain types of annuities are more like investment products than others, like fixed indexed annuities, for example. As a reminder, fixed indexed annuities or fias are annuities whose returns are generally linked to a market index, like the SP 500, up to a certain cap and or participation rate, while protecting against market losses, meaning that your principal and any amount that has been credited to your FIA account will be 100% downside protected. If you want to learn more about FIAS, I've linked this video in our annuity playlist below for your convenience. SPIAs serve a different purpose than FIAs, though, in my mind. I tend to think of SPIAs first and foremost as the insurance products for longevity that they fundamentally are. They insure us against the risk of living too long and running out of money. This SPIA will send you your monthly check for as long as you live, even if you live to 97 or 107. And on top, it's much less complicated than building a 20-rung bond ladder like this one on your own. Now, it's not always an easy decision to choose between an annuity and a bond ladder. And as you know, I'm generally a big fan of bond ladders and buying individual bonds and holding them to maturity. But as I always say, everyone's financial journey is different. And here's how I personally think about the SPIA versus bond ladder decision. Consider a SPIA if in order to sleep well at night, you want the guarantee that your annuity check will come every month for as long as you live. In this case, an annuity provides a simple, easy way to manage longevity risk and make sure you won't run out of money. For example, you could use an annuity to add an additional source of guaranteed lifetime income that helps you to plug the gap between your essential living expenses and your other guaranteed lifelong income from Social Security and a company pension, if any. And if you build such a floor, you could then even be a bit less conservative with the rest of your portfolio. You might also be more tempted by an annuity if your margin of error for longevity is smaller and you're afraid that your remaining portfolio wouldn't be able to cover your essential living expenses once the bond ladder has fully matured. And consider a bond ladder if you're not overly concerned about longevity risk, running out of money, or building a guaranteed lifetime income stream to cover your essential living expenses. For example, because you have a portfolio that should comfortably cover your expenses even after the bond ladder has run its course. And as usual, the decision for a bond ladder will be easier the more you have the knowledge, time, money, and comfort level to build a bond ladder that suits you. That said, you may not necessarily have to make an either-or decision. You can have both annuities and bonds in your fixed income portfolio, like some in our Diamond Nestec community do. As I always say, it doesn't have to be an all or nothing situation. So if you're interested in learning more about SPIAS or any other type of annuity to see what might be best for you, then drop us a note at jennifer at diamondnestic.com. We've barely scratched the surface today. If, on the other hand, you're more interested in building out a bond ladder, then visit our website at www.diamondnestic.com and click on this Bond Beginners and Bondmasters course bundle button here to learn more. And in case you want to model out your own SPIA versus bond ladder comparison like the one we showed you here, keep these points in mind. First, the minimum purchase requirement for bonds with the leading brokers is typically$1,000,$5,000, or in some cases even higher. So these principal values we've shown you here would need to be rounded up or down as appropriate. If you buy from Treasury Direct, the minimum and incremental purchase quantity for T-bills, notes, and bonds is only$100, but not all of these maturities are available for purchase at auction via Treasury Direct. 2. We have assumed an average interest rate of 4.25% across all maturities and annual payments for the sake of simplicity. You can also assign individual interest rates to each rung of your bond ladder and model your payments out monthly, depending on how detailed and or complex your model is. 3. As we discussed earlier, this sample analysis does not factor in taxes or inflation. Taxation on annuity payments and interest payments is based on a number of factors, including which account you're purchasing them in, the types of bonds you're buying, and on the most basic level in which tax bracket you are and where you live. Also, do note that this is not the only way to build a bond ladder that mirrors this SPIA's annual payment of$7,200, but it is the way we find exposes you to the least amount of reinvestment risk and market risk. So what do you think? Are annuities for you? Why or why not? And do you have more questions? Drop a comment below and let me, Marcus, and the community know. All right, members, Super Savers and Course fans, I hope you enjoyed this video and learned something new. And see you again very soon with more brand new, wealth-building content for your financial journey.