Managing Risks in Retirement by Diversifying Sources of Retirement Income

Periodically I venture somewhat outside my field of expertise to tout the potential virtues of having a diversified portfolio of sources of retirement income.  Most retirees in the United States are currently receiving (or will receive) Social Security benefits and most have accumulated some retirement savings (either in tax qualified plans or in after-tax investment accounts).  A smaller percentage of retirees are currently receiving (or will receive) some form of lifetime income from defined benefit plans sponsored by one or more of their prior employers.   Still others rely on income from employment to supplement their retirement income. 

In our post of September 22, 2013, I indicated that it is not unreasonable to manage risks in retirement by diversifying sources of retirement income and compared several partial annuity/partial self-managed approaches with either using 100% of accumulated savings to buy a single premium life annuity or alternatively investing the accumulated savings and using a strategic withdrawal approach to develop annual spendable income.  Last week I also blogged about Qualified Longevity Annuity Contracts (deferred life annuity products that provide more "pure" longevity insurance than single premium life annuities at generally significantly lower cost).  

In his article in the July/August 2014 Contingencies Magazine, Mark Shemtob, an actuary, argues that there is no "puzzle" why retirees don't buy single premium life annuities--They don't believe the potential perceived risks justify the potential perceived rewards.  The potential risks summarized by Mr. Shemtob include:

• Insurance company default
• inflation risk
• liquidity risk
• risk of dying too soon

And while I agree with Mr. Shemtob that these risks might prevent me from taking 100% of my accumulated savings and buying a single premium life annuity, I can mitigate some of these risks (and take advantage of the rewards inherent in annuities) with a partial annuity/partial self-managed approach. 

How much of one's accumulated savings should be used to buy either a single premium immediate annuity, a deferred annuity or some combination of the two?  And when should one buy these annuities?  I don't know.  This answers will depend on many factors, including expectations for current and future interest rates, amounts of Social Security benefits and employer sponsored lifetime income you receive, bequest motives, your investment risk tolerance, your basic income needs, your desire for budget flexibility, etc. 

I do know, however, that you can use the "Excluding Social Security V 2.0" spreadsheet on this website to coordinate your withdrawal strategy with annuity purchase decisions you are considering to estimate the effect on your annual spending budget.