The risk of inflation is important when swapping real for nominal dollars. Rather than ending the fear of outliving your 401(k), QLACs can exacerbate it.
First, you can set any inflation and rates of return you'd like. Second, the market has current expectations, which we use as defaults. Third, there is substantial inflation risk, which is why we encourage MaxiFi users to run What Ifs. So, I'd recommend you run using the default assumption, but also consider higher nominal rates of return and nominal inflation rates such that the real rate -- the difference between the two -- stays constant. Also, my cell is 617 834-2148 if you'd like to discuss, pls call. Best and thanks for using MaxiFi, Larry
I recently purchased two QLAC annuities for my wife and I. We initially learned about these in your book "Money Magic", where you say on page 90, and I quote,"I recommend you rethink annuities, particularly the new annuity kid on the block: QLACs,....." I note that the book's first edition was in 2022, after the start of the inflation rise in 2020.
Lest you think I would risk my hard-earned just on a suggestion in a book, I went and plugged in annuities that began at age 85 for both of us into Maxifi. The software, which I have enjoyed using and which I now base many of our financial decisions generated a higher standard of living beginning immediately, and continuing until the 100 yr-old cutoff.
Hi KHarvey. The annuity is going to increase your highest affordable living standard in MaxiFi because the default inflation assumption is relatively low and your maximum age is likely set to 90-100. This just highlights the fact that annuities provide longevity insurance, i.e., protection against the risk of outliving your money.
I would consider running an alternative profile with the same annuity but a 2x or 3x higher long-run inflation assumption. At some higher inflation figure, the value of the annuity will decline to the point where your highest affordable living standard is no longer better than without the annuity (but with the higher inflation). Essentially, you can use the model to iteratively solve for the level of inflation that would be necessary to make your living standard equivalent (or worse) than without the annuity.
Thanks Larry. Yes, QLACs clearly involve taking on more inflation risk in exchange for mitigating longevity risk. Based on an individual's entire financial picture, this may or may not be a good trade-off, but importantly it depends on the individual situation. Another thing to note is that buying a deferred income annuity or QLAC can give you greater capacity to take on more investment risk (i.e., holding relatively more stocks in your remaining investments). Although not an inflation hedge, stocks may keep pace with rising prices over long periods of time and may provide some upside vs bonds.
Lastly, using MaxiFi, I have run multiple alternative profiles exploring the impacts of high sustained inflation on income annuities. First off, otherwise higher inflation can clearly erode one's affordable living standard. However, I have found that deferred income annuities, like QLACs, surprisingly provide better downside protection against higher inflation vs immediate income annuities, likely because of the significant mortality credits they provide. In short, you can not entirely avoid inflation risk when buying income annuities that pay a nominal benefit, but deferred income annuities may ultimately be a better bet than immediate annuities if you experience bouts of high inflation in retirement (assuming you live a long time, of course!).
Ditto, Larry
Hi Don,
First, you can set any inflation and rates of return you'd like. Second, the market has current expectations, which we use as defaults. Third, there is substantial inflation risk, which is why we encourage MaxiFi users to run What Ifs. So, I'd recommend you run using the default assumption, but also consider higher nominal rates of return and nominal inflation rates such that the real rate -- the difference between the two -- stays constant. Also, my cell is 617 834-2148 if you'd like to discuss, pls call. Best and thanks for using MaxiFi, Larry
I recently purchased two QLAC annuities for my wife and I. We initially learned about these in your book "Money Magic", where you say on page 90, and I quote,"I recommend you rethink annuities, particularly the new annuity kid on the block: QLACs,....." I note that the book's first edition was in 2022, after the start of the inflation rise in 2020.
Lest you think I would risk my hard-earned just on a suggestion in a book, I went and plugged in annuities that began at age 85 for both of us into Maxifi. The software, which I have enjoyed using and which I now base many of our financial decisions generated a higher standard of living beginning immediately, and continuing until the 100 yr-old cutoff.
So what gives? I'm gonna lose sleep over this....
Hi KHarvey. The annuity is going to increase your highest affordable living standard in MaxiFi because the default inflation assumption is relatively low and your maximum age is likely set to 90-100. This just highlights the fact that annuities provide longevity insurance, i.e., protection against the risk of outliving your money.
I would consider running an alternative profile with the same annuity but a 2x or 3x higher long-run inflation assumption. At some higher inflation figure, the value of the annuity will decline to the point where your highest affordable living standard is no longer better than without the annuity (but with the higher inflation). Essentially, you can use the model to iteratively solve for the level of inflation that would be necessary to make your living standard equivalent (or worse) than without the annuity.
Thanks Larry. Yes, QLACs clearly involve taking on more inflation risk in exchange for mitigating longevity risk. Based on an individual's entire financial picture, this may or may not be a good trade-off, but importantly it depends on the individual situation. Another thing to note is that buying a deferred income annuity or QLAC can give you greater capacity to take on more investment risk (i.e., holding relatively more stocks in your remaining investments). Although not an inflation hedge, stocks may keep pace with rising prices over long periods of time and may provide some upside vs bonds.
Lastly, using MaxiFi, I have run multiple alternative profiles exploring the impacts of high sustained inflation on income annuities. First off, otherwise higher inflation can clearly erode one's affordable living standard. However, I have found that deferred income annuities, like QLACs, surprisingly provide better downside protection against higher inflation vs immediate income annuities, likely because of the significant mortality credits they provide. In short, you can not entirely avoid inflation risk when buying income annuities that pay a nominal benefit, but deferred income annuities may ultimately be a better bet than immediate annuities if you experience bouts of high inflation in retirement (assuming you live a long time, of course!).
If expected inflation is high why does MaxiFi assume 2.25/2.5% inflation. Is my retirement planning via MaxiFi simply pie in the sky by and bye?