Annuity confusion

I’m baffled.

My basic profile is very simple: Among other things it assumes my nominal investment return on qualified and unqualified money matches 3% inflation (i.e. zero real return), assumes my wife and I both die at age 100, and inputs as special receipts the payouts of three immediate annuities, two of which are currently paying out, and the third of which is due to start paying out in June of this year. I don’t assume a house sale, insurance, leaving a legacy, or anything else to complicate matters. I plan to retire at the end of 2019.

I have the option of delaying the start of payout of the third annuity anywhere up to 5 years, if I make the decision within the next few weeks. I spoke with the annuity company (New York Life) and found out what the payout would be if I delayed the start for 2 years, or for 5 years (obviously higher in both cases), and found out in each case what portion would be taxable for the first 14 to 16 years, until the non-taxable component added up to my initial premium, at which point everything would be taxable going forward.

I combined all the taxable and non-taxable payouts on an Excel spreadsheet for each scenario (start third annuity payout in 2018, in 2020, and in 2023). I then made two copies of my basic profile, cleared the special receipts grid, and entered the proper numbers for the two delayed payout scenarios, being sure to enter both taxable and nontaxable receipts, and being sure to use dollars and not today’s dollars (since there is no inflation adjustment). So I now have three basic profiles, differing only by the start date of the third annuity.

When I ran all three reports, the suggested spending for the three scenarios differed by less than a tenth of a percent, i.e. almost identical. So if we both live to exactly 100, and our real investment returns are zero every year, it doesn’t matter which option we choose.

Then, in each of the three scenarios, I changed both our deaths to age 95. In the first scenario (third annuity start date 2018), the suggested annual spending DROPPED by about 1.5%, which seems awfully counterintuitive. In the second and third scenarios, the suggested annual spending increased by around 20%, which seems more reasonable.

Obviously I’ve done something wrong, but I’ve checked everything carefully, and can’t see a problem.

Any ideas?

Comments

dan royer's picture

OK, well it sure sounds like you know what you are doing. The first thing I'd do is replicate my experiment to make sure that I didn't accidently change some other variable. That's just me I guess; I tend to want reassurance that I'm comparing apples with apples. Sometimes the user interface can play tricks and not do what you think it's doing. Next, I'd make sure that this somehow didn't create liquidity constraint--that is, your suggested discretionary is smooth all the way to the end, right?

I'd be glad to look too, but I'd need the database via a support ticket.

Is the answer in taxes somehow?

I think the answer is either that I have somehow screwed up the data, though I was very careful, or that there is some sort of bug in ESPlanner, with the former of course far more likely. I can't imagine taxes would lead to such a huge discrepancy. Since I'm almost 75, and my wife is 79, the 20% increase in scenarios 2 and 3 that I get for knocking 5 years off our lives seems about right; it's the first scenario that doesn't make any sense, with our income dropping by dying 5 years earlier. Yet leaving our deaths at 100 produces almost identical results in all three scenarios, which kind of makes sense given the way annuity payouts are determined from mortality tables, and absolutely the only thing I then changed in scenario 1 was the ages. And yes, the suggested discretionary spending is smooth all the way to the end, except a little bit higher in the very last year of my life.

I don't have time right now, but sometime in the near future, probably next weekend, I'll go over everything with a fine tooth comb. If I can't find an error, I'll create a support ticket.

Okay, found the error. The basic profile, from which I copied the other two, changing only the start date of the third annuity from 2018 in the original to 2020 and 2023 in the copies, somehow had its nominal investment return reset to 0%, for all three asset classes (i.e. regular assets, and my and my wife’s retirement assets), from 3% (same as my assumption for inflation), at the same time that I changed the death ages from 100 to 95. I have no idea how this happened, the copies all have the original 3%, and I would never have changed the nominal returns assumptions on the original basic profile to zero deliberately (I’m not that pessimistic, though maybe I should be), and it would be extremely difficult to do accidentally.

Having fixed that error, I then ran the numbers with death ages set to 105. The interesting finding was that the start date of the third annuity (and it is a significant one, would probably account for a bit over 5% of my discretionary spending, hard to come up with an exact percentage given the peculiar tax treatment of immediate annuities) is almost irrelevant. I would have thought that holding off for five years with the consequent 37% increase in annual payout would really pay off if you lived a very long time (e.g. age 105), but for each death age assumption, 95, 100, and 105, the discretionary spending ALWAYS DECLINES with each delay in annuity start date, though the difference between starting in 2018 and starting in 2023 is less than 0.15% in discretionary spending in each case, little more than a rounding error. Kind of startling consistency. Never could have figured this out without ESPlanner.

Okay, found the error. The basic profile, from which I copied the other two, changing only the start date of the third annuity from 2018 in the original to 2020 and 2023 in the copies, somehow had its nominal investment return reset to 0%, for all three asset classes (i.e. regular assets, and my and my wife’s retirement assets), from 3% (same as my assumption for inflation), at the same time that I changed the death ages from 100 to 95. I have no idea how this happened, the copies all have the original 3%, and I would never have changed the nominal returns assumptions on the original basic profile to zero deliberately (I’m not that pessimistic, though maybe I should be), and it would be extremely difficult to do accidentally.

Having fixed that error, I then ran the numbers with death ages set to 105. The interesting finding was that the start date of the third annuity (and it is a significant one, would probably account for a bit over 5% of my discretionary spending, hard to come up with an exact percentage given the peculiar tax treatment of immediate annuities) is almost irrelevant. I would have thought that holding off for five years with the consequent 29% increase in annual payout would really pay off if you lived a very long time (e.g. age 105), but for each death age assumption, 95, 100, and 105, the discretionary spending ALWAYS DECLINES with each delay in annuity start date, though the difference between starting in 2018 and starting in 2023 is less than 0.15% in discretionary spending in each case, little more than a rounding error. Kind of startling consistency. Never could have figured this out without ESPlanner.

Don't know what happened. I tried to edit my reply to correct the erroneous 29% in the middle of the second paragraph to 37%, and wound up with two copies, the original and the corrected.

dan royer's picture

I'll check when I get time if I can replicate that change of rate of return. If doing it again you can replicate, let me know. The way these numbers all mutually influence each other is so complex it's sometimes baffling.