While income annuities are frequently recommended by advisors to increase guaranteed income, the products do not always improve financial security in retirement, new research concludes.
The Society of Actuaries, Schaumburg, Ill., makes this claim in a January 2013 report, “Measures of Retirement Benefit Adequacy: Which, Why, for Whom and How Much.” Conducted by the society’s Pension Section Research Committee, the study reports the impact on a hypothetical’s couple’s income and wealth for each of three scenarios: one involving no annuity; and two alternatives in which 25 percent and 50 percent of the couple’s wealth is annuitized.
Assuming the client generates $150,000 in annual income and has $1 million in accumulated wealth, the study finds that the probability of having wealth at death is 82 percent in the “base case” (zero percent of wealth annuitized). The probability declines to 33 percent and 6 percent, respectively, when the proportion of initial retirement wealth used to purchase a life annuity is changed to 25 percent and 50 percent.
The report adds that, 50 percent of the time, the couple’s remaining wealth at death is $1.47 million in the base case and $0.00 when either 25 percent or 50 percent of wealth is annuitized. However, 95 percent of the time the remaining wealth at death is $6.03 million in the base case, $1.4 million when 25 percent of wealth is annuitized and $90,350 when 50 percent of wealth is annuitized.
Additionally, 95 percent of the time, the number of years that income is insufficient to meet the couple’s needs is 9 years in the base case, 19 years when 25 percent of wealth is annuitize and 25 years when 50 percent of wealth is annuitized.
Retirement wealth that would have been sufficient to meet the needs of the couple 95 percent of the time is $1.53 million in the base case, $1.71 million when 25 percent of retirement wealth is annuitized and $1.7 million when 50 percent is annuitized.
“When a couple does not annuitize, running out of investment wealth leaves them with only Social Security income,” the report states. “In contrast, a couple who has purchased annuity and runs out of other investment wealth will have greater annual income than they would have otherwise.
“Although not modeled in this report, it is likely that the purchase of an annuity at a later age or the purchase of a deferred annuity would be a better financial strategy because it would more directly address longevity risk, but at a lower up-front cost,” the report adds.