In addition, income annuities provide longevity protection, which is unavailable with traditional bonds. Trying to meet a spending objective from a bond fund will inevitably lead to portfolio depletion down the road, while income annuities provide income for your entire life.

Since the insurance company providing the annuity is investing those funds primarily in a fixed-income portfolio, we can essentially think of income annuities as part of the retiree’s bond allocation. Here, income annuities offer something bond funds cannot: mortality credits. Those who wind up experiencing short retirements subsidize the income payments of those with longer retirements.

This is known as “longevity protection.” The income annuity is able to make payments, anticipating that someone will reach his or her life expectancy, because of this risk pooling feature. Thus, as I said earlier, income annuities are “actuarial bonds.”

This is how the reward component of the efficient frontier works. Counterintuitively, liquid financial assets can be larger later in retirement if there is a partial annuitization. To show this more clearly, I offer an example in Figure 1 that compares a retirement strategy with only investments to a strategy that includes partial annuitization.

I profiled a couple, as an example, who share a birthday. They are approaching 65 and ready to retire. With a nest egg of $2 million, they would like to fund $89,586 of spending from their portfolio—with a 2% annual increase to cover inflation—for the rest of their lives. I assume that there will be a fixed inflation rate of 2% and real compounded returns of 6% for stocks and 1% for bonds. (These are actually quite generous return assumptions that would favor an investments approach.)

The couple considers two possibilities for funding their spending goals in retirement. Option 1 is to use investments only: withdraw from a 50/50 portfolio of stocks and bonds, rebalanced annually. Option 2 is to annuitize half of their portfolio at retirement to cover the fixed-income allocation and keep the other $1 million in stocks.

Based on the numbers at my Retirement Dashboard for the start of 2015, the payout rate for an annuity that pays 100% to a surviving spouse after the first spouse dies and has a 2% annual cost-of-living adjustment is 4.4%. The annuity income grows from a base of $44,000, and the remainder of the couple’s spending goal is covered through systematic withdrawals from their investment portfolio.

With both investments only and partial annuitization, the couple is able to fund their $89,586 equally well. Figure 1 tracks the amount of liquid financial assets remaining for them after they have met this spending objective. In early retirement, liquid financial assets will clearly be less with partial annuitization. Half of the retirement assets were annuitized with no refund provision in the event of early death.