Saturday, July 30, 2016

Increased Monthly Annuity Payments

This post has gotten way too long. So I am writing the end here at the beginning [and rewriting what was below on how I got here in the next post].

How can increased monthly annuity payments reduce total benefits (payout)? Because the first payment is 10, 20, 30, 40, and 50% lower than the not increased monthly benefit rate, and the calculator “interest rate” needed to schedule the ever-increasing payments is not great enough to catch up (Chart 20).

The annuity calculator for setting the fixed no benefit rate (that works perfectly) begins to drift off course as the marketed increased payment rate rises from 1% to 5%. The calculator is the perfect model for setting the fixed rate (Chart 19).

It duplicates the chart in the marketing brochure (Chart 16).

The mystery was solved when I realized the same calculator was being used for both monthly payment rates: fixed monthly payment benefit rate and the five increased monthly payment rates. I could now use the calculator to explore the behavior of trying to match lower starting monthly payments to increased monthly payments.

Chart 20 shows that the total payout drops very little with a 1% and a 2% increased monthly payment. No problem here. At 3%, the calculator “interest rate” needed to maintain a 3% increased payout is a bit more than 3%; at 4% it is 5%; and at 5% it is 7.5% with the fixed rate calculator still failing badly when used in this way; nearly $7,000 off track.

Charts 21 and 22 show how it goes off track. The marketing is good. Get a 5% increased monthly payment each year. I believed it. Why question? I then asked Excel to show me the actual increase in relation to the marketed increase. What a surprise!

The claim that the increased payment is 1% or 2% is good. At 3% there is a gentle decline of about 0.5%; not an increase. There is about a 1% bonus at the start of the 5% claim followed by a drop of over 2% by the end of the 20-year contract. Not enough money is paid out during those last high monthly payment years. The result is a $6945 loss in monthly payments for the illustrated contract in relation to the fixed rate monthly payment contract we are buying (please see the next post if you are interested in the details). 

Valid comparisons between contracts (annuities and CDs) must show the amount in the pot, the duration of the contract, and the total payout. I need these three values to work through a reinvestment scheme in a new post.

The marketing from the 10% personal bank loan (in the next post) to the 5% increased payment annuity does not count with one exception. My fixed rate annuity calculator generates an interest rate that can be compared to simple interest (CD interest) as a common denominator, if I have that last increased payment from the increased payment contract.

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