R Bonds R Bad 4 U

I have long been a fan of immediate annuities, particularly those that are inflation indexed, as retirement products for seniors.  Yet, they do not get bought by retirees.  Why?  Well, insurance products are sold, not bought, typically, and when the agent sells an immediate annuity, that is his last sale on that money.  They would rather sell a less suitable product that offers them another sale down the road.  And, people like having flexibility with and control over their investments, even if that leads to less money for them in the long run.  Annuitizing a portion of one’s lump sum lowers risk, and takes the place of investing in bonds in the asset allocation.

Most people like the reliability of their pensions, and Social Security, should it be paid, but do not seek the same thing when investing their private money.  One would think they would invest that money for growth if they had a strong stream of income elsewhere, but often that money is conservatively invested as well.

People get fooled by yield, and in an environment like this, more so.  People try to make their investments do more through targeting higher yields, while ignoring the possibility of capital losses.

Most people can budget, if pressed to do so.  Few can manage a lump sum of capital, and know what to invest it in, and how much to take from it per year.  Few have the discipline to buy an immediate annuity or limit their withdrawals to 4% of assets per year.

But where there is chaos and confusion, some in our government will seek to create a “solution.”  The ill-defined solution that sounds a bit like a Stable Value Fund is what is getting called “R Bonds.”  Here’s the idea: for those with 401(k)  or IRA balances, if they should retire, and not decide what to do with the money, the assets would get automatically get placed into a Retirement Bond, and for two years, the retiree would receive income.  They can opt out before that happens.  If after two years they still don’t decide, the income continues.  There is nothing mandatory about this program, should it come into existence; people who are asleep about their finances may find themselves trapped in it, at least for a time. [Note: there are scandalmongers alleging out-and-out theft being planned by the US Government.  From what I can see that is not true for anyone that keeps his wits about him.  All the proposals allow people to “opt out.”]

But let me go further.  Scrap the idea of “R bonds.”  Issue a limited number of Trills for retirees to use, or create a special variant of TIPS that pays until someone dies.  These are easy solutions that do not require a lot of changes to the legal codes, or changes in investment behavior.

Now, there is not just one proposal out there.  Let me give the two most comprehensive:

With interest rates so low on the short end, I don’t see how the returns could be that great from “R Bonds.”   I would play for higher returns given the risk of inflation.  Today that would mean safe stuff that yields little, while waiting for a correction in the fixed income markets, and high quality common stocks with some yield.  And, annuitization at present?  I would wait for higher rates.

Other posts on the topic worthy of your consideration:

Now, all that said, there is a reason to be politically aware here.  Governments have in the past forced people to convert assets that were more valuable for those that were less valuable.  And, we have the example of Argentina doing it in the present with pension assets, and also when their currency blew up — most debtors faced a forced conversion to less valuable bonds.  With the pension nationalization, it was done in the name of protecting people’s pensions, but ended up benefiting the finances of the Argentine Government.

So, be aware.  R Bonds, as currently proposed, are a bad idea.  But there are worse ideas not yet proposed that might be proposed in the guise of protecting your future.  Let us work to make sure they never get implemented.

6 Comments

  • Another note on Argentina from the FT — timely. The holdouts on the original forced conversion are still fighting, and Argentina’s finances are still a mess:

    http://www.ft.com/cms/s/0/e35a943e-005e-11df-b50b-00144feabdc0.html

    I would say this, for the most part, nations that cheat debtors usually remain mired in crisis because trust is necessary for a government to function well, both internally and externally.

  • Lurker says:

    There are a slim number of situations that annuities fit; those that have optimized all of their other tax strategies, those that need judgment-proof income, maybe the few special cases that have reason to believe offloading their longevity risk onto an unsuspecting insurer will be profitable for them?

    You’re right about annuities getting “sold” and not “bought.” Even the one-time sales are so loaded with commissions that significant performance is sucked up by the agent and not delivered to the customer.

    Laddered five- or ten-year Treasuries, handled via a fee-only advisor relationship, are probably a better retirement solution for most, compared to annuities.

  • huskercr says:

    One might even consider adding foreign government bonds to the ladder mix in order to diversify some portion of retirement income away from the risks of dollar depreciation and US government default. (Yes, I realize that governments able to issue debt in their own currency should never default – but we don’t know if the US will always be able to do so, and never say never.)

    Another concept that I find intriguing is longevity insurance, which can be in the form of an annuity with the first payment deferred until some future date – say age 85 for coverage bought at age 65. This type of coverage should be relatively cheap and could help in planning what amount of savings could be spent each year.

  • matt says:

    David:

    What do you think about spreads here? My friends are giving me the pity look because I moved into AA and higher fixed incomes this month. I really don’t like the spreads of anything lower quality.

    Also, do you see a flattener on the horizon? If so, which end of the curve are we likely to see the most twist action? My opinion is the long end, but I’d like to see what you think.

    Cheers,
    Matt

  • Jim says:

    David,

    You are a “fan of immediate annuities”. I’ve just finished analyzing the choices and deciding to take a lump sum rather than immediate annuity (*not* inflation indexed) from one company I worked for. So I’m wondering if I missed something.

    My approach was to calculate NPV for a few scenarios, discounting by typical 30-year-window inflation rates, and looking at a few values of years-of-payouts around my life expectancy. My conclusion is that the NPV of the annuity option is about the same as the lump sum if inflation is in a normal range, but that if inflation takes off (a distinct possibility in my opinion), I’m better off with the lump sum (all the details are in the latest post at my site, clearonmoney.com, if you are interested).

    Does the approach seem reasonable to you (I am not an actuary!)?

    By the way, I recently quoted your post about market turning points, which I found very helpful.

    Best,

    Jim

    • Jim, your approach is reasonable. I am a fan of immediate annuities because they provide longevity insurance, and can substitute for high quality bonds in an asset allocation. Credit risk issues can be ameliorated by reviewing guaranty fund coverage, and dividing annuities up into smaller parts.