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Life Health > Annuities > Fixed Annuities

Annuity Skeptics Show When Immediate Annuities Could Shine

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What You Need to Know

  • Jack De Jong and John Robinson note that other researchers have championed income annuities as alternatives to bare portfolios.
  • De Jong and Robinson contend that bare portfolios with static distribution rules usually beat SPIAs.
  • Bare portfolios combined with dynamic distribution strategies could be even more likely to beat SPIAs, the researchers say.

Two analysts who are skeptical about broad retiree use of income annuities have shown when the products might beat ordinary portfolios of stocks, bonds and cash.

The analysts, Jack De Jong and John Robinson, contend in a new working paper that bare portfolios, combined with static cash distribution strategies, will outperform income annuities in about 90% or more of the investment market scenarios produced by their simulation system.

Cutting cash distributions when conditions are poor will help bare portfolios perform even better, De Jong and Robinson predict.

Given that only harsh, long-lasting bear markets are likely to deplete portfolios, and that annuitizing can lead to a significant wealth sacrifice, “we conclude that the consumer decision to retain control over the spending portfolio instead of purchasing a SPIA seems decidedly rational,” the analysts write.

But the analysts also suggest, in exhibits showing the results of their forecasting efforts, that single-premium immediate annuities could help holders keep their income flow and nest eggs in some market scenarios that would wipe out the nest eggs of retirees without SPIAs.

Mortality credits could help single SPIA buyers get a positive return on investing around age 90, and they could help couples with joint-life SPIAs break even around age 91 or 92, the analysts report.

What It Means

Clients who care more about maximizing income in 90% of market scenarios may continue to prefer to hold their nest eggs outside of annuities.

Clients who are more afraid of going broke in extreme bear markets than in living well in other scenarios may continue to want to hear about SPIAs.

Income Annuities

Annuity contracts are financial arrangements that can convert a pot of cash into a stream of income payments.

U.S. life insurers design many annuity contracts as vehicles for accumulating assets. The focus in the design of these products is more on helping the holder accumulate assets inside of an annuity than in generating income.

An income annuity contract is an annuity designed to produce income.

Some consumers who have retired and need spending money may simply withdraw cash from a bare investment portfolio or accumulation-oriented annuity.

Other consumers who need income use their retirement savings to make one big payment for a single-premium immediate annuity.

A SPIA is an annuity contract designed in such a way that it can convert one large lump-sum payment into an income stream that can last a lifetime.

De Jong and Robinson

Jack De Jong is on the faculty of Seattle Pacific University.

Robinson is a financial advisor based in Honolulu and the co-founder of Nest Egg Guru, a product that financial advisors can use to help clients test savings and spending strategies.

De Jong and Robinson have presented their paper as a response to papers by researchers, such as David Blanchett and Michael Finke, who have suggested that retirees should be making more use of SPIAs to maximize retirement spending capacity and retirement nest egg security.

Longevity Protection

De Jong and Robinson present an exhibit illustrating the performance of annuity mortality credits under a wide range of market conditions.

They say the exhibit shows that, in their simulations, mortality credits help only retirees who live well into their 90s.

“The internal rates of return from annuitization for all four of our real-world SPIAs do not turn positive until our 65-year-old purchasers approach age 90 or later (25-plus years),” the analysts write.

“Although retirement researchers frequently cite mortality credits as a reason for investors to consider SPIAs as a substitute for individual bond portfolios, our results suggest that the actuarial value of mortality credits in retail immediate annuities — at least for retirees in their 60s — may be significantly offset by the issuing insurance companies’ administrative and distribution costs and profit motive,” the analysts add.

The analysts say earlier research has shown that retirees tend to value spending in the earlier years of retirement more than in the later years.

Government program safety nets and “buffer assets” held outside the investment portfolio may reduce the risk that portfolio depletion later in retirement will cause serious problems, the analysts contend.

Market Risk Management

The heart of the new De Jong-Robinson paper is a collection of exhibits showing how a SPIA contract might perform, for a 65-year-old single investor or couple with $1 million in assets, over 30 years, when compared with various portfolios of stock, bonds and cash, in a variety of market scenarios.

The authors also include an exhibit showing what might happen if the retirement savers replaced the cash and bonds in their portfolios with SPIAs.

The authors assume that initial withdrawals and fees could amount to 3%, 4% or 5% of the asset total.

The authors used a figure equal to cash distributions plus the remaining balance as their performance measure.

In most of the investment-performance-based exhibits, in a large majority of the scenarios, retirees who put all of their assets stock or stock funds generated the best results.

In the typical market scenarios, holders with all of their assets in stocks and stock funds ended up with a total of $4 million to $7 million in cash distributions and balances.

But, in the exhibits based on investment performance, in the worst 1% of market scenarios, savers who had SPIAs beat the retirees without SPIAs. They ended up with totals for cash distributions and balances ranging from $1 million to $2 million.

In most of the exhibits, SPIA holders beat the other retirees in 10% of the market scenarios.

In some exhibits, SPIA holders beat investors without SPIAs, and just 60% of assets held in stocks or stock funds, in 20% of the market scenarios.

Clarification: The authors note that they see the market scenarios produced by their simulation system as illustrations of possible market conditions, not as predictions or indications of how likely the scenarios in the simulations are to occur.

(Image: Sergey Nivens/Adobe Stock)