Many of the posts and articles on this site (as well as retirement research) suggest retirees consider managing risks in retirement by adding a combination of (i) lifetime pension/insurance annuity products and (ii) withdrawals from a managed portfolio of assets to the benefits received from Social Security. Because annuity products such as single premium immediate annuities (SPIAs) and deferred income annuities (DIAs) pool mortality risk and share mortality gains among survivors in the pool, these vehicles can be more efficient in managing longevity risk than withdrawals from a managed portfolio. These products can also be more effective in managing investment risk. On the other hand, withdrawals from a managed portfolio can preserve spending flexibility, provide liquidity to meet unplanned expenses, serve as a hedge against inflation, and can provide a bequest motive, which may not be as easily accomplished with annuity products. Therefore, depending on the relative size of a retiree’s accumulated savings, the existence or non-existence (and relative size) of a pension benefit and the amount of the retiree’s Social Security benefit, the best approach to managing retirement risks may be this partial annuity (or pension)/partial withdrawal approach.
As illustrated in several of my most recent posts, retirees may want to separate their total spending budget into several smaller components, including for example, essential health-related expenses, essential non-health-related expenses, other unexpected expenses, non-essential expenses and bequest motives/other end of life expenses. Investment and payout strategies for these various component budgets could easily vary. For example, retirees may select more conservative investment (such as annuity products) and payout strategies for assets supporting essential expenses while employing more aggressive investment and payout strategies for assets supporting non-essential expenses.
If a retiree elects to use a partial annuity (or pensions)/partial withdrawal approach and either does or does not separate total spending into smaller components, it is important that the withdrawal strategy applied to invested assets be appropriately coordinated with payments expected to be received under the pension/annuity in order to meet the retiree’s spending objectives. Note that with the exception of the Actuarial Approach recommended in this website (and possibly the actuarial approach developed by David Blanchett, John Mitchell and Larry Frank), none of the more commonly-advocated withdrawal approaches make any attempt at all to properly coordinate with fixed dollar pensions or lifetime annuity products that a retiree may have. This failure to properly coordinate is, in my opinion, a serious deficiency for withdrawal strategies such as the 4% Rule (or any of its many variations), the required minimum distribution rules (RMD), any safe withdrawal rate (SWR) approach, the Annually Recalculated Virtual Annuity (ARVA) approach or even the Guyton Decision Rules inexplicably touted by Dr. Wade Pfau, the author of the “Efficient Frontier” retirement research noted above which advocated the combined use of annuities and withdrawals.
Two recent articles got me started on this post. The first article, Government Policy on Distribution Methods for Assets in Individual Accounts for Retirees--Life Income Annuities and Withdrawal Rules, by my friend and former business colleague, Mark Warshawsky, compares historical outcomes of 100% investment in annuities vs. 100% investment in a balanced portfolio of equities and fixed income assets with withdrawals made under the 4% Rule. Based on historical simulation of asset returns, interest rates and inflation, Mark concludes that the 100% annuity strategy beats out the 100% investment strategy. He uses this conclusion to make several retirement-related government policy recommendations. For the most part, I found this to be good research, but I would have liked Mark to include comparisons of combined partial annuity/partial withdrawal strategies, and I am not a big fan of the 4% Rule.
The second article, by the aforementioned Dr. Pfau, entitled 7 Risks of Retirement Income Planning, indirectly makes a pretty compelling argument for combining annuity products and investments to address all of the risks discussed in this article.
