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.
Thirty percent said they could save more but don’t, and 26
percent admitted they have more debt than they should. 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.
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.
Non-annuitized 401(k) assets were held in a 50/50
stock-to-bond blend, and paid a low fee (20 basis points). Historical
valuations of the Standard and Poor’s 500 stock index were applied, and 4
percent was drawn down from the assets annually, producing a dollar amount that
was raised annually with the price of inflation.
While Warshawsky’s research may require a Harvard PhD to
validate, he insists he’s deploying a simple comparison, and that while
immediate annuities faired well in his models, they certainly are not the best
option for every situation.
Retirees with more assets, and those with significant
defined benefit pensions might not need annuities to guarantee they don’t
outlive their assets. And those hoping to one day bequeath assets, as well as
those who can predict a shorter life expectancy, will be uneasy with the
annuity option—once assets are surrendered in premium to a contract, they’re
not coming back.
Others knock annuities for their interest rate risk, or what
Warshawsky prefers to call their “timing risk.”
His data certainly shows some fluctuation in what a $100,000
annuity pays out. In 2008, the average payment issued to a 65 year old was near
$700 a month. In April of 2014 that average was below $550.
While current low interest rates are definitely something to
take into consideration—Warshawsky favors a laddered approach to annuitizing
portions of savings in this climate—he reminds that rising rates are bound to
be equally volatile on stock holdings that remain in plans or invested lump
sums.
And though he supports the annuitized option enough to put
his money where his mouth is (Warshawsky has started a private advisory that
uses annuities, in part, to address retirement income distribution), he
stresses that they are one option that can be part of a solution to some
investors, but certainly not all.
There is a natural tension between the two options, which
Warshawsky says goes up the “food chain,” from advisors, to plan sponsors, to
the financial institutions with an interest in one option over the other.
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