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I noticed that annuities are now yielding almost 6%. A 45 y/o male, for example can buy a 5.63% lifetime stream of income plus 10 years after his death for his beneficiaries. If he delays income for 2 years, that becomes 5.87%, and of course the payout goes up from there. I suspect these payouts will be even higher by 2Q 2023.
It seems annuities could reduce SORR by fixing some percentage of one's income and protecting one against the risk of having to reinvest their bond AA at lower rates someday in the future. In a Japanification scenario, this could save one's retirement. I will try entering a custom income stream in the spreadsheet to see what happens to SWR - when I get a chance 🙄.
Of course downside of annuities and long-duration fixed income is that the payout is unchanging in nominal terms. Thus these payments are eroded by inflation in a way that stock earnings are not necessarily. If annuity payouts reach 7%, it will be tempting to place a bold bet on a low-inflation future, but that would leave one vulnerable if we have, say, 5 years of 10% inflation. Yet, forward inflation expectations are currently very low. This is obviously a tool we could use to address disinflationary SORR events, but not really address inflationary SORR events.
I wonder if there is a way to hedge this risk using options on the Federal Funds Rate or SOFR. I.e. if rates are high on some series of future dates, it'll be good these options made money because one's annuity payments will needs some assistance. Today's low implied 2 year and 5 year inflation rates suggest such insurance could be bought cheaply. Anyone have thoughts here?
Source: https://www.immediateannuities.com/
Once you knock off an expected inflation rate of 2.5% you're down to an effective WR in the low-3%. Much worse than what you could achieve with a diversified stock/bond portfolio right now. I'm still not convinced.
Annuity yields are now quoted at 6.3% for the demographic described above. Interestingly, the quoted rates have gone the opposite direction as long-term treasuries this month. Cannot explain.
Perhaps I accidentally implied a 100% annuities AA above, but what I had in mind was something more like 30-40%. E.g. a person with a $1M portfolio and $40k expenses might put $350k into annuities earning $22k/year. Then their remaining $650k portfolio would "only" need to earn the remaining $18k/year (2.7% in year 1) and keep up with inflation in the following years.
Seen through this lens, the annuity investment would be like having a paid-off mortgage, or solar panels, or a garden where you grow much of your food, or of course a pension. It reduces the percentage of consumption that is subject to SORR risk. It reduces the shortfall in SORR years, to the point where belt-tightening and side gigs are plausible defenses. Earning plus saving $18k in today's dollars during a recession is a lot easier than earning plus saving $40k.
Presumably you'd use equities for the remaining $650k because of the need to outrun inflation in the long run. The risk with this AA would be the stock portfolio not sufficiently returning at least (100/65=) 1.54X leveraged inflation on the withdraws, in addition to each year's withdraw.
Therein lies the gamble. Can $650k in equities gain 25x the compound increase in inflation on $40k living expenses over a long retirement? If inflation will be about 2-3%, that's probably doable, but if inflation runs closer to 5-6% then our WR from the equity portfolio starts going up from 2.7% to something less sustainable.
This is why I was contemplating how to hedge inflation. Taking an inflation-bullish position on the treasuries/TIPS spread futures, options, or swaps markets might make the portfolio bulletproof, but at a cost.
Another downside compared with bonds is that with most annuities, we lose the ability to easily "sell" the asset to rebalance. Thus, no matter how cheap equities get in the future, we cannot rebalance without paying a high surrender fee. An investor in the mid-to-early 1980s, for example, who had bought an annuity yielding these rates back in the early-1970s, might desperately regret not having the liquidity to pile into stocks. They'd be stuck with a low real income for life. However the flipside is also true: You'd be immune to having to reinvest at low rates upon bond maturity.
(Sidebar: for many people in the U.S. their continued survival may at some point depend on their ability to promptly write a six-figure check for a surgical procedure or patented medication, so the annuity could be deadly in that regard.)
But overall, it's always been a winning bet to assume the Fed will beat inflation eventually. To me, this AA looks good for the investor who has conviction that inflation will go down soon, and stay down. They'd be locking in a lifetime stream of payments at the high water mark.