Can a balance of withdrawals and annuities outshine the 4% rule?

A strategic balance of annuities and systematic withdrawals, tailored to individual needs, preferences and market conditions, is the key to optimal retirement outcomes, according to new research by economists Mark Warshawsky and Gaobo Pang.

Warshawsky is principal of ReLIA Strategies, former deputy commissioner for Retirement and Disability Policy at the Social Security Administration (2017), and current senior fellow at the American Enterprise Institute. Pang is principal of Zillore LLC. The research was supported by the American Council of Life Insurers (ACLI).

The research realistically models the many uncertainties that retirees face: investment returns, inflation, lifespan, and other individual circumstances, as well as the pricing of investment and annuity products purchased at retail or institutionally.

Insights from the survey

The findings unveil crucial insights for the future of retirement security for Americans. They are:

• A strategy of systematic withdrawals from more liquid investments or cash savings, combined with annuities, outperforms other strategies for anyone retiring with $250,000 and more in savings – be that via a one-time purchase of an immediate annuity or a gradual, laddered process of annuitization.
• The popular 4% rule is problematic. While offering flexibility, this rule – withdrawing 4% of initial wealth, subsequently indexed to inflation each year – has significant failure rates at older ages and provides the lowest level of income, the research said. Conversely, annuities offer a guaranteed lifetime income, safeguarding against market volatility and longevity risk.

The researchers came to the conclusion that full or partial annuitization leads to better retirement incomes than the 4% rule by showing that the 4% rule resulted in considerable risk of running out of money late in life, a plausible and worrisome outcome, especially for couples, explained Warshawsky. “By contrast,” he said, “annuity combination strategies guarantee steady income flows for life, while still leaving assets to grow for future distributions, bequests and late-in-life needs like nursing care.”

• Those consumers retiring with less than $250,000 benefit the most by annuitizing higher portions of their savings, if not all. Why is this the case? Warshawsky said that according to estimates of retiree preferences found in professional literature, most prefer to get higher income flows in retirement, until higher wealth levels allow them to consider other goals like bequests. “Annuitization maximizes the income available to retirees,” he said.
• Overall, annuities maximize a steady flow of income, can reduce the strain on the remaining nonannuitized wealth, and accommodate wealth growth.

“The retirement landscape has undergone significant transformations in recent years, with the traditional reliance on defined benefit plans shifting towards defined contribution plans and individual retirement accounts. These plans lack built-in means for a retiree to know how to best structure their regular withdrawals to fund their lives in retirement, and annuities fill that gap,” said Warshawsky.

“There’s more research to be done to explore the right mix for those who are partially retired, as well as into how annuitization can overlay Social Security, other investment options, and different kinds of employer pension and retirement plans.”

Industry implications

Warshawsky added that the research in this paper has significant implications for policymakers and financial advisors advocating for policies that support flexible, mixed-income strategies. It also underscores the importance of educating retirees about the benefits of diversifying their income sources in retirement.

“For all but the wealthiest of their clients,” he added, “financial advisors should use retirement income distribution strategies that include immediate annuities, as these combination strategies reduce the risk of income shortfalls while still maintaining portfolio growth for bequests and late-in-life needs. Taxes, in the way of minimum distribution requirements, are no longer a disincentive with the passage of SECURE 2.0 legislation removing the double taxation of annuity payouts.”

 

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