Are plan sponsors and participants giving immediate annuities short shrift in designing income distribution strategies?
One Harvard PhD and veteran retirement wonk has published a working paper suggesting that may be the case.
Mark Warshawsky, a visiting scholar at George Mason University’s Mercatus Center, a think-tank dedicated to market-oriented policy solutions, has been testing the value proposition of immediate annuities on and off for three decades.
His latest research takes an apples-to-oranges comparison of the efficiencies of a annuitized retirement strategy versus the “Bengen” principal—the 4 percent drawdown rule on 401(k) investments that has arguably become the default approach to managing defined contribution assets.
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The immediate annuity market is not very active,” said Warshawsky, who served a central role at Treasury crafting the Pension Protection Act of 2006 and has been the director of Retirement Research at Towers Watson.
After all of his research, that still surprises Warshawsky, who expects the uncertainty facing this generation of retirees will force greater consideration of annuitized options.
“In the past, people were lucky. Stock markets went up, housing prices went up, government was providing more benefits through Medicare, and people had pensions. If you retired 10 or 20 years ago you likely found yourself in a pretty good situation,” he said.
“Going forward, none of that is going to be true. People need to be much more sharp and efficient in dealing with longevity risk,” added Warshawsky.
To be clear, his research shows that annuities are not always a viable option. Retirees in their 50s might not benefit from an annuitized strategy because of the contracts’ illiquidity; tie assets up in an insurance contract and they won’t benefit from the time younger retirees have to see them grow in the market.
But Warshawsky found that as people approached the more typical retirement ages of 62 to 70, annuities produced a higher average income three-fifths of the time compared to the 4 percent Bengen rule.
He generated projections of the income produced on a $100,000 immediate annuity, using historical yields on 10-year Treasury bonds and different lifetime simulations, to see how the payouts compared to the 4 percent drawdown strategy.