How annuities optimize retirement income

Financial advice often focuses on the accumulation phase of retirement planning. But the decumulation phase — when households seek to generate sufficient income in retirement to meet their spending needs — requires an equal focus.

Research from BlackRock and the Bipartisan Policy Center showed how a comprehensive approach to retirement planning that includes annuities can help individuals generate adequate income from their accumulated assets and accomplish two critical retirement planning goals.

The research was presented during a recent webinar from the National Association for Fixed Annuities.

Retirement savers benefit from a holistic approach to retirement income that focuses on three principles of decumulation, said Kate Tan, BlackRock quantitative researcher for retirement solutions. Those principles are:

1. Maximize spending ability.
2. Maximize spending certainty.
3. Address longevity risk.

Adding guaranteed income and delaying retirement (and delaying Social Security claiming age) can boost total annual spending in retirement and reduce downside risk, the research showed.

“We looked at how to strike a balance with maximizing spending ability and maximizing spending certainty,” Tan said. “Then we added in the longevity risk and asked, are there better ways to do this than have been done in the past? Things such as annuities and guaranteed lifetime income can address all three of these principles.”

A case study

BlackRock developed a case study showing how adding annuities to a retirement plan optimizes the amount of money a retiree has available to spend in retirement. The case study looks at a hypothetical saver who is 35 years old, earns $44,000 annually, and wants to retire and claim Social Security at age 65.

In the base case, the saver allocates 40% of their retirement assets to equities and 60% to fixed income but does not include a guaranteed income product.

“What our saver realizes is that the size of their nest egg at retirement doesn’t guarantee income stability by itself,” Tan said. “They do two things. They deploy other tools: Strategy 1 and Strategy 2. They also take a holistic view in Strategy 1, where they see that changing one element may require them to change another element.”

Strategy 1 is to have 50% of the saver’s retirement assets allocated to equities and 50% allocated to fixed income and include a guaranteed income product.

“Because they have some future income needs that are now guaranteed by adding the annuity, they can increase the percentage of equity allocation in their portfolio,” Tan said.

Strategy 2 is to maintain the same retirement asset allocation and include the guaranteed income product but delay the age of retirement and claiming Social Security to 67.

The study findings showed that adding the annuity to the saver’s retirement strategy increases the amount of spending from that saver’s retirement savings, Tan said.

By incorporating guaranteed income in their strategy, the saver is able to spend 35% more in their first year of retirement than they would without the guaranteed income product. In addition, the saver is able to have a 29% average spending increase over their retirement span.

Adding an annuity also raises the floor on the retiree’s spending, the study showed. The addition of guaranteed lifetime retirement income provided an annual spending floor of $46,170 in the first 15 years of retirement.

This represents a 33% increase over the $34,598 annual spending floor that the retiree would have had in the first 15 years of retirement if they had used their 40/60 allocation in their original plan and did not add an annuity.

Adding guaranteed lifetime income to the plan accomplishes two client goals, Tan said:

1. It reduces the pressure to underspend early in retirement and save for later years, allowing more flexibility in spending earlier in retirement.

2. It provides a higher and more reliable spending floor in retirement.

Meanwhile, an even higher level of spending in retirement is possible from adding guaranteed lifetime income to the retirement plan while delaying retirement and delaying Social Security, Tan said.

“This strategy increases the size of the retirement nest egg, shortens the retirement period and increases the Social Security benefit,” she said.

Susan Rupe is editor in chief, magazine, for InsuranceNewsNet. She formerly served as communications director for an insurance agents' association and was an award-winning newspaper reporter and editor. Contact her at [email protected].