ANNUTIES-How can we use them?

[NTL]

You have no choice but to pay taxes (and thank goodness our tax rates are as low as they are). You have no choice but to obey the laws of the land. There is no such thing as 100% free choice.

We have ample evidence in other countries that a long term sustainable pension scheme is one that pays for itself without being a burden on future generations of tax payers.

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Let me give you something to think about. I did this quickly for fun. Let's say that you have $100,000. And you decide to self insure. You need a bit of math and excel skills to follow this argument.

According to the SingStat website http://www.singstat.gov.sg/publications/...and_deaths

The proportion of males still alive at age 95 given you are alive at age 65 (i.e. probability of survival conditional on age 65) is 0.06. This is not a low number. However, I will assume you can plan your self-insurance until then.

I have seen posters assume they can make 5% returns if they self-insure. This cannot be a riskless portfolio. I model this as a mean return of 5% with a standard deviation of X%. e.g. if X is 1%, it means that 2/3 of my returns are between 4 to 6% (assuming normal distribution).

On a excel sheet, I basically use the norminv(rand(), mean, stddev) function to model the random returns in any one year. I then can simulate N number of scenarios (basically a monte carlo) and find out how many scenarios out of N do I run out of money by age 95.

On a $100K sum, I will assume an annual withdrawal rate of $8000 (which is similar to current estimated CPF life payouts on 100K of capital), I also assume that you invest the 100K at age 55 without any withdrawal until age 65 - again similar to CPF life.

My N is 16380 scenarios (basically about the width of the excel sheet :-)).

(A) For a mean return of 5% and a stddev of 3% (ie 2/3 of returns fall between 2% to 8%), I get 258 scenarios in which you have a 0 or lower principal at age 95 (1.57% of total scenarios).

(B) For a mean return of 5% and a stddev of 1%, I get no failures. with a stddev of 2%, I get 0.07% failure rate.

© For a mean return of 5% and a stddev of 4%, I get 1029 failures or 6.28% of total scenarios.

Now, statistically speaking you have a 6% probability of surviving until age 95 at the time you start withdrawing money. This means, you have a small but non-zero chance of running out of money for any reasonable risky condition.

What's the intuitive reason for this? Well, 8K is 8% of 100K. So when you draw a $8K pension, you may be drawing down capital. Even in bad years, you still draw down $8k, eating into your capital. That's why the results vary even though your mean return is still 5% per annum.

The assumption of normality in your return profile is, i would say, probably optimistic. It should show high kurtosis - i.e. you need to assume black swans. For example, even if you assume your average return is 5%, there may be entire stretch of years in which your return is very negative (I do not need to reach further back than 2008 for an example), but you still need to have your income to live on.

In conclusion, even if you assume a higher rate of return than an annuity's investment float, you will need to keep a buffer for the lean years. This may result in a withdrawal rate scarcely better (if at all) then with an annuity and with no certainty that you won't outlive your capital.

Hi tanjm,

Dunno how to use excel for such calculation.

Just wondering how about having a wider standard deviation? Say +/-12%? This will give returns from -7% to +17%? What will be the probability of having enough till 95?

Reason why I ask that is I am not very optimistic, and fearing withdrawals of investments during down periods. My greatest fear will be prolong down period in the initial years. Can excel simulate that scenario?

If I intend to withdraw from age 45, to last till 95, what will be the withdrawal rate that will almost guarantee (>99%) that I will have sufficient?

Thanks.

[Temperament]

What is actually CPF's MS in the first place before CPF LIFE comes into the picture?
It's GOV forcing everyone to self insured in the 1st place but still have a choice to use this MS to buy an annuity from an insurance company when you reach 55 or 60 years old. Now you have no choice (born after 195X or 196X). Ha! Ha! But still some people may like it this way. i think some people are just happier someone do the thinking for them.
My maths may be only "O level" but i still try very hard to think for myself leh. Never mind if my thoughts may be "limited" by my maths but i can imagine and learn from others who have higher IQ's. -Their ideas and concepts are enough to make me think better without my understanding of their higher maths. Ha! Ha! Don't believe? Temperament?

[tanjm]

Hi tanjm,

Dunno how to use excel for such calculation.

Just wondering how about having a wider standard deviation? Say +/-12%? This will give returns from -7% to +17%? What will be the probability of having enough till 95?

Reason why I ask that is I am not very optimistic, and fearing withdrawals of investments during down periods. My greatest fear will be prolong down period in the initial years. Can excel simulate that scenario?

If I intend to withdraw from age 45, to last till 95, what will be the withdrawal rate that will almost guarantee (>99%) that I will have sufficient?

Thanks.

Please note this is only a simulation. It is meant to illustrate the perils of self-insurance. The "standard deviation" in a normal probability distribution basically says that there is a 2/3 liklihood of it happening within the mean plus minus the standard deviation. e.g. if mean=5%, stddev=5%, this means 2/3 of the annual returns will be between 0 and 10%. however 1/3 of returns will be **outside** and can be negative or very positive. Also, you are right to be pessimistic because the real world is worse than a "normal distribution" because there will be black swans to account for.

In my opinion, I would get an annuity to cover my "basic needs" (food, utilities, health insurance etc), and self insure for the rest - stuff I can afford to do without if necessary. Then in a down year, I simply spend less.

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What is actually CPF's MS in the first place before CPF LIFE comes into the picture?
It's GOV forcing everyone to self insured in the 1st place but still have a choice to use this MS to buy an annuity from an insurance company when you reach 55 or 60 years old. Now you have no choice (born after 195X or 196X). Ha! Ha! But still some people may like it this way. i think some people are just happier someone do the thinking for them.
My maths may be only "O level" but i still try very hard to think for myself leh. Never mind if my thoughts may be "limited" by my maths but i can imagine and learn from others who have higher IQ's. -Their ideas and concepts are enough to make me think better without my understanding of their higher maths. Ha! Ha! Don't believe? Temperament?

Sounds like your objections are tinged with anti-gov sentiment. In that case, logic doesn't work. Since I tend to be a logical person, I'd have to say "nuff said!".

[Temperament]

Ha! Ha!
In theory there is no difference between theory and practice. In practice, there is.

[tanjm]

Something tells me u like to have the last word.

[Temperament]

Something tells me u like to have the last word.

Yes! Don't you remember who started this thread? i think i would like to, logically speaking? May be not logical thinking again to you? To you, (i think ) anyone having a different opinion and anti GOV's policies is not logical. In this sense 40% of the people has been illogical since the last GE.
Anyway i like to close here. You can carry on if you want to. Cheers!
Shalom.

[tanjm]

Like i said.

[Musicwhiz]

OK guys, relax. Let's keep things civil and friendly.

[tanjm]

The attraction of this website is the focus on investments. It's disconcerting to see political agenda disguised as investment discussions. Not only that, but its a disservice (and damaging to valuebuddies long term reputation) to the 90% of people who come here to get a neutral opinion on financial products or companies.

If I were talking about annuities generally (not CPF life), I wouldn't get such a response.

[HitandRun]

The attraction of this website is the focus on investments. It's disconcerting to see political agenda disguised as investment discussions. Not only that, but its a disservice (and damaging to valuebuddies long term reputation) to the 90% of people who come here to get a neutral opinion on financial products or companies.

If I were talking about annuities generally (not CPF life), I wouldn't get such a response.

Relax bro. Although Uncle Temperament is unabashedly anti-govt, I believe that he has a point. Most retirees couldn't care less or understand how the govt arrived at the computations. They are only interested in certain questions, e.g.

1. How much am I going to get on a monthly basis?
2. When will the govt stop paying me?
3. What happens to the money should I "expire" prematurely?

Therefore, if they can get more in the new scheme (CPF Life), their support will likely be higher.