Optimizing A Retirement Portfolio Using Annuities
A pre-retiree heads into retirement with many goals, some at odds with others. Often these goals include: maintaining a high standard of living, not running out of money, leaving a legacy after death, etc. But, a retiree’s number one goal must be to not run out of money. In reality, having the right financial situation such that one can continue living without work and not run out of money is the definition of retirement.
This is becoming increasingly difficult in today’s retirement landscape where the decline in pensions has transferred market and longevity risks onto the individual, leaving them far more susceptible to running out of money (i.e. having no personal savings or income streams other than Social Security, which is generally not enough to live off of, forcing a reduction in one’s standard of living). And, because the mutual fund industry via 401(k)s and IRAs currently dominates retirement planning, most conversations around money in retirement are about accumulating wealth to then support some level of retirement spending, instead of talking directly about locking in one’s ability to spend. Mutual funds and other market investments offer individuals the opportunity to take risk, not to eliminate it like pensions and annuities do.
The dominance of the mutual fund model, along with human tendency to under-insure, has left the majority of Americans unprepared for retirement and concerned about running out of money. As a Fellow of Society of Actuaries and an employee of Blueprint Income (digital annuity platform), this problem has been a focus of my professional career.
Annuities, whether purchased individually or in group format as with some pensions, along with Social Security, exist to help individuals avoid running out of money in retirement. Because of the pooling of longevity risk across participants, annuities are able to offer “mortality credits” which result in them outperforming bonds with respect to the goal of not running out of money. In this paper, and relying heavily on the good work done before me by retirement income experts, I demonstrate how adding annuities to one’s retirement portfolio reduces the risk of running out of money. Moreover, I provide a new model for optimal asset allocation that goes beyond stocks and bonds to include annuities.
