Thanks to increased longevity and the lack of traditional pensions, one of the many questions clients face when shaping their retirement portfolios is whether or when to move money to an annuity.
Conventional wisdom among economists has been that most people should annuitize their investments, because doing so will allow these clients to spend more each year without outliving their money.
But a new research paper, entitled Lifetime Expected Income Breakeven Comparison Between SPIAs and Managed Portfolios, suggests this conventional wisdom may not hold true.
When is the best time for clients to buy a single premium immediate annuity (SPIA)? It turns out, the answer is: much later than most imagine. And, in some cases, the paper suggests, annuitizing may not make sense at all.
The paper is based on a study by Larry Frank Sr., a financial advisor with A Better Financial Education Inc. in California; John Mitchell, a professor at Central Michigan University; and Wade Pfau, a professor at the Pennsylvania-based American College of Financial Services. The paper compares possible outcomes of annuitizing or managing a portfolio throughout retirement.
The researchers calculated that the break-even age between annuitizing using an SPIA vs managing two model portfolios – one with a 50% equities allocation; the second, 20% – and the likelihood of outliving the break-even income levels for various annuitization ages ranging from 65 to 85.
For the most part, the paper suggests, managing a portfolio of stocks and bonds produces greater overall wealth than using SPIAs.
Implicit in this comparison are two assumptions: retirees value consumption equally in all years of retirement; and they don’t feel the same way about bequests. In other words, retirees want no worries about running out of money, and can accept their heirs winding up with less.
According to the paper, although annuities pay out more than managed portfolios initially, managed solutions deliver greater returns over time – even factoring in different asset allocations, fees and the impact of inflation.
For clients interested in leaving a legacy, this group tends to come out ahead by keeping their assets in their own hands and bequeathing the eventual remainder – even if they outlive 70% of their peers.
There are, however, times when an SPIA might make sense. For instance, an SPIA provides protection for those who anticipate having a longer than average life expectancy and expect to endure a long bear market. The paper suggests that clients under the age of 70 might consider an SPIA under such circumstances, but most clients would fare better if they postponed their decision.
If a client did enjoy a greater than average life expectancy, he or she might consider buying an SPIA, although not until well into retirement. In general, though, the paper suggests that most people shouldn’t consider such a purchase until after age 75.
Even for those younger than 80, the paper suggests that retirement assets are best kept in a managed situation, both to protect heirs and allow future market returns to create additional income.
An alternative strategy may include “laddering” annuities – particularly in such a low interest rate environment – or purchasing an SPIA as the client needs additional income while staying invested in an age-appropriate portfolio for longer time frames.
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