Saturday, July 25, 2015

Combining Investments with Insurance in Retirement

This post is a follow-up to our post of June 18 entitled, “Managing Risks in Retirement through Diversification of Retirement Income Sources.”  The impetus for this post is another excellent article by Dr. Wade Pfau entitled, Evaluating Investments versus Insurance in Retirement, featured in the June 30, 2015 edition of Advisor Perspectives.  And while Dr. Pfau does a fine job of presenting the advantages and disadvantages of exclusively using either investments or insurance to fund retirement, his primary purpose is to advocate combining the two approaches in retirement.  He concludes that “retirement income planning is not an either/or proposition” and “the risk pooling features of insurance and the upside potential of stocks make for an effective combination for retirement income.”  As this combining of retirement income sources has been a pretty consistent theme of this website for quite a while, I will take this opportunity to once again point out how intelligent Dr. Pfau is. 

Of course it would have been nice if Dr. Pfau had been a bit more specific with regard to his recommendations regarding 1) proportions of each type of investment 2) timing of annuity purchases or 3) types of annuity purchases (immediate annuities or deferred income annuities, QLACs).  But perhaps these recommendations will be forthcoming soon from the eminent retirement researcher. 

As emphasized on our June 18 post, the Actuarial Approach advocated in this website is one a very few approaches that actually attempts to coordinate fixed dollar insurance annuities (or pensions) with withdrawals from investments when developing a retiree’s spending budget.  Most other approaches assume a 100% investment approach (and/or simply ignore the existence of annuities/pensions).   If a combined fixed immediate annuity (or pension)/investment approach is used, the withdrawal strategy needs to do double duty.  Withdrawals from investments must not only provide supplementary lifetime income with desired cost-of-living increases on such income, but must also provide for desired cost-of-living increases on the fixed dollar annuity.   If a combined deferred income annuity (QLAC)/investment approach is used, withdrawals from investments must work even harder.  Such withdrawals will be the sole source of income prior to commencement of the deferred annuity (together with desired cost-of-living increases).  After commencement of the deferred annuity, withdrawals from investments need to provide supplementary income (together with desired cost-of-living increases on such income) as well as desired cost-of-living increases on the fixed dollar deferred annuity income.  But don’t worry.  Unlike the many other commonly-advocated withdrawal strategies, the Actuarial Approach does all this coordination for you automatically.