Subject: Re: Dividends
All of this SWR discussion inevitably leads back to annuities, and (especially with Jim in the thread) tontines.

And his BAC-L ($1,179) and WFC-L ($1,180) yielding 6.2% and 6.4% today.

https://discussion.fool.com/a-...

The link broken?

From my notes:

Q.

The Times had a recent article on "How to make you money last as long as you do" which has been a topic here as well. They quote a financial planner who has done some Monte Carlo simulations of the possibilities of running out of funds and found that delaying social security until age 70 helped considerably but that adding a single premium immediate annuity reduced the risk of running out of funds to essentially zero. The kicker? For $298k this annuity would generate $12k/year (~4% yield). Our much-discussed WFC/L is currently above 6% yield, so perhaps you could avoid the financial planner and do considerably better?

Jim.

The difference is far more than it appears in that comparison.
In one case it's a yield, and in the other case it's mostly return of capital.

Let's say you go for one or the other deal today for $298k, inflation is 2%/year, and you croak 20 years from today.
WFC/PL is trading at $1199.60 today. Let's call it $1200, so the $75 coupon is exactly 6.25%.

Between you and your estate, how much do you get from the annuity?

For annuities I believe that only a very small and changing portion of the amount is taxable for Americans. Let's say 5% just so we don't ignore it?

So, you receive $12k payments for 20 years or $240k, which after inflation equates to $190710 in today's money.
After tax, that's around $181794 in today's money, which is 60.8% of your original money.
The other 39.4% of your money (in purchasing power) is lost and gone forever.
Even with zero tax and living to 103, you have had a negative real return on your money after 38 years.
Only in year 39 do you start to come out ahead on the deal, at age 104, and your rate of return at that point is less than 0.1%/year.

If you buy WFC/PL instead, you get 248.33 shares, paying a coupon of $75, total $18625/year pretax.
Let's assume you're US based and a top tax bracket kind of guy and pay 23.8%, so that's net $14192 per year after tax in today's dollars.
So, your real after-tax return after 20 years to your assumed death gets you $225550 in coupons overall in today's money, which is 18% more than the annuity gave you.

But...and here is the kicker...your estate still owns the preferred stock.
Assuming the price is still $1200 in then-current dollars, it's worth $741.77 per share in
today's dollars or $184206. There is no capital gains due if it's sold, as the nominal price hasn't changed.
Losing 2%/year in value to inflation is a lot better than losing it all.

So, after 20 years you (including your estate) end up putting in $298000 and end up with either
* $181794 total back in today's money from the annuity, after taxes and inflation
* $409756 total back in today's money from the WFC/PL, after taxes and inflation

The thing to remember about an annuity is that you are not *investing* that money.
It is an insurance premium expense, and once given over to the insurer, the principal never comes back to you.
Thus the payments are not a yield at all, but little steps back up out of that really big initial hole.
They are priced so badly that you have to live a *really* long time for it to be better than simply running down the pile of cash it would have cost you.

(that $298000, again without inflation protection or any return at all, will obviously last 24.8 years at a $12k/year rundown rate as there is no tax)


A disadvantage of the WFC/PL in these really long scenarios is that it's not perpetual.
There is the likelihood that each WFC/PL that cost you $1200 will get forcibly exchanged for $1300 worth of WFC common stock...eventually. Maybe 16-25 years out?

Your earnings yield is probably going to be a bit lower on the common than than the yield on the preferred, and "payments" will
get irregular (selling bits of stock when the market value of the block rises in real terms above its initial level).
But it does mean that you start getting inflation protection from that point onwards.
Hardly a wipe-out.

Previously I have suggested to people to use a mix of mainly WFC/PL for yield and a little WFC common to "insure" against the forced conversion.

The only scenario that you get the forced conversion is the scenario wherein WFC has gone up by 3.5 from today's price,
so when you eventually lose yield from the WFC/PL you have done wonderfully on the WFC common.
On certain assumptions a portfolio of 1/3 WFC and 2/3 WFC/PL would keep your yield from dropping below
its initial nominal level when the conversion happens, which is 4.90% pretax at current prices and yields.
You also get a material amount of inflation protection on your coupons, though not complete.