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The Real Effect Of Immediate Annuities On Retirement Sustainability

Saving money while you’re working and gradually accumulating a retirement nest egg are the first steps in planning for retirement. But things don’t stop there. Addressing your income requirements during retirement should be a part of your strategy. Covering essential expenses should be part of your retirement income strategy (e.g., housing, food, utilities, insurance). It should also allow you to earn money to accomplish things you enjoy (e.g., buying a new boat or traveling). An immediate annuity is a financial product created to assist you in generating lifelong income that is guaranteed. For obvious reasons, the prospect of a lifetime income stream guaranteed through an immediate annuity is tempting. But is it a sustainable approach? Previous research has shown that partial annuitization lowers the likelihood of financial asset depletion and may even allow you to build a higher portfolio legacy value over lengthy retirement periods. However, recent research analyzed the actual effect of immediate annuities on retirement sustainability.   According to the research, when retiree wealth is examined from a total balance sheet perspective, a significant portion of the advantages offered by a stock/SPIA strategy can be explained by the implied rising equity glide path underlying the approach by taking into account the present value of remaining single-premium immediate annuity (SPIA) payments as a way to show the implied stock/bond asset allocation glide path. They compared the relative performance of static, stock/SPIA, and dynamic stock/bond portfolios that follow a stock/SPIA strategy to disentangle the effects of the glide path and the impact of mortality credits. The study’s conclusion demonstrates that earlier research that suggested the advantages of partially annuitizing a retiree’s portfolio frequently showed the benefits of a rising equity glide path using a bucketed liquidation strategy that spends down fixed assets first and enables the household equity allocation to increase. The unique mortality credit contribution from SPIAs can only be helpful for retirees who live well beyond the average lifespan; the rest of the SPIA “benefit” can be achieved by using bonds and stocks with a rising equity glide path. Although this research shows that SPIAs can improve retirement success, this benefit is only material for retirees who live well past the average lifespan. For people who do not live to their expected lifespan, SPIAs only have a positive effect since the rising equity glide path’s value (which can be achieved without the SPIA) surpasses the negative impact of mortality credits. The findings also demonstrate that inflation-adjusted SPIAs are more efficient than fixed SPIAs because of the larger payments in later years. This is because the principal benefit of SPIAs accrues to individuals who live longer than expected. According to the research, the main situations in which SPIAs should be used are those in which they are intended to reduce longevity risk beyond life expectancy significantly. In other cases, it is more efficient for most retirees to implement the rising equity glide path that bucketed SPIA strategies indirectly create. Consequences of the research The findings from this research have significant ramifications. They suggest that the majority of earlier studies that suggested a benefit of partially annuitizing a retiree’s portfolio were actually showing the benefits of a bucketed liquidation strategy that first spends down fixed assets and then permits the household equity allocation to increase, not an advantage of the single-premium immediate annuity itself, especially in scenarios that don’t extend materially beyond life expectancy. As an illustration, Ameriks et al.’s findings showed that over a 25-year time horizon, no annuitization resulted in a 5.8% risk of depletion, while 50% annuitization reduced that failure rate to only 0.6%. However, this research demonstrates that when liquidation strategies with similar glide paths are modeled, most or all of the implied benefits of SPIAs disappear at these time horizons. SPIAs continue to provide a valuable advantage for people who substantially outlive life expectancy to enhance retirement income sustainability. Real SPIAs perform better in such a “longevity hedge” capacity than nominal SPIAs. Although only a tiny portion of retirees are expected to reach the benefit threshold, given today’s low return environment, the crossover takes even longer to achieve. This is because actual SPIAs need a long enough time horizon to make a substantial contribution. Since the assumption of this research does not account for distribution costs or a profit margin that would be built into the pricing of actual products that are for sale, the results of this research are still slightly weighted in favor of the SPIA; to the extent that real-world SPIAs have payout rates somewhat lower than the results shown here.
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