Five Facets of a Secure Retirement

2. Finance Market Risk Tolerance

Conservative investors prefer certainty; they want downside protection and guaranteed income. Therefore, conservative investors should have a higher allocation to longevity insurance than aggressive investors. The average conservative retiree may want almost 60% in guaranteed products, while aggressive retirees may want half that amount.

3. Wealth Versus Retirement Expenses

The ratio of total net worth to retirement expenses not covered by existing guaranteed income (such as Social Security and defined benefit pension income) has a large impact on the allocation to annuity products. Retirees with a high ratio of around 80, i.e., those with a great deal of wealth relative to non-covered expenses, have no need for longevity insurance. Their portfolios can withstand market downturns and longevity risk without threatening their living standard. On the other hand, an investor with a more moderate wealth gap ratio of 20, for example, may want to allocate 40% of assets to annuity products.

4. Risk Preference Toward Longevity

Using mortality tables, it’s easy to determine a person’s life expectancy, but that number is just an average. People have more detailed knowledge of their family history, lifestyle and general health than what mortality tables can tell them. Therefore, clients should be able to make a qualitative assessment of their life expectancy. Those investors who expect a higher probability of living longer than average life expectancy or who are simply more concerned about living a longer life may want to allocate as much as 65% to guaranteed products as opposed to 35% for an investor who expects a shorter lifespan, all else being equal.

5. Bequest Goal

The trade-off between “spend it in retirement” and “leave it to heirs” also has a large impact on the optimal annuity allocation. Clients who want to spend their retirement income in their lifetime (the “spend it in retirement” approach) should have a larger allocation to longevity insurance, with the allocation tilted toward immediate fixed annuities instead of VA+GLWBs. Clients who want to leave the largest possible bequest to beneficiaries need less longevity insurance. The allocation within the annuities portion should tilt more to VA+GLWBs because the contract value is paid to the investors’ beneficiaries on death. They likely will also benefit from investing in traditional assets, such as stocks and bonds.

The burden on retirees to finance their own retirement spending is growing. Fortunately, there are solutions. Most investors can avoid an extreme outcome by allocating a portion of their portfolios to insurance products that offer guaranteed income for life. But, advisors and investors have to be careful in how they determine the proper allocation to these products. Using our research results as guidelines, advisors can go a long way to helping their clients manage longevity risk and have a fruitful retirement.