The results of his research, based on Monte Carlo simulations, show that the best mix of assets includes a 25% to 45% allocation to immediate annuities, deferred income annuities and/or a ladder of immediate annuity contracts. Today, only about 2% to 4% of retirees' assets are in immediate annuities.
If you wanted to minimize the probability of ruin, you would invest more money in a fixed immediate annuity. Take a 65-year-old male, with a life expectancy of 19 years, assets of $1 million and annual expenses of $50,000. Our subject wants a minimum estate value of $100,000. To achieve a 0% probability of ruin, he would invest 75% in a fixed immediate annuity and 25% in mutual funds. This, Zhou says, is essentially a risk-free investment. The estate at the end is worth $928,000.
But as annual expenses rise, so does the risk of ruin, and the ending estate value declines. If the 65-year-old man had $63,000 in annual expenses, the probability of ruin would be just over 7%. He would invest 85% in a fixed annuity, 3% in a deferred immediate annuity and 12% in mutual funds. The estate would be worth $250,000 after 19 years.
The same man who wanted to maximize the end value of the estate would need to take a more aggressive stance: A 90% investment in a variable income annuity, 3% in a deferred income annuity and 7% in mutual funds would result in a 5% probability of ruin and an estate value at his death of $1,779,000.
Rising annual expenses, however, would force him into a more conservative stance to keep his probability of ruin at just 5%. If he had $62,000 in annual expenses, he would invest 70% in a fixed immediate annuity, 5% in a variable immediate annuity, 4% in a deferred immediate annuity and 21% in mutual funds. The ending estate value would be $413,000. "A well-designed immediate annuity and investment strategy generally outperforms a pure investment strategy," Zhou says.
Matthew Grove, vice president of retirement income security with New York Life, says financial advisors are showing a strong interest in the use of immediate annuities in retirement plans, looking at both optimization and the risk of ruin to find the right mix of insurance and investments for a client.
More than $300 million has gone into the company's new Guaranteed Future Income Annuity, a deferred fixed immediate annuity launched last August. Policyholders fund the annuity before they retire and get immediate income later when they hang up their spikes. The average policyholder, Grove says, is 58 years old and puts $100,000 into the annuity-but delays the lifetime income until he is about 68.
MetLife's retirement division, meanwhile, offers a product called the Longevity Income Guarantee annuity. Bennett Kleinberg, a senior actuary at the firm, says that the strategy of some financial advisors is to put about 10% to 20% of a 50-year-old's assets into this vehicle. The annuity pays a fixed amount of monthly income to the retiree later at age 85. Because the future income is guaranteed, the retiree can invest more money elsewhere in stocks or feel safe withdrawing from other income sources.
For example, a 65-year-old retiree can put $425,000 in investments and $75,000 in the deferred immediate annuity. He would get $21,500 a year from a 5% systematic withdrawal plan from his other investments starting at age 65. Then at age 85, the immediate annuity income would kick in, replacing the systematic withdrawals from other accounts. This annuity would offer $22,300 annually.
But Kleinberg says it can also be set up so that the annuity income starts before a client is age 85. And if the policyholder dies, joint owner or survivor payout options will ensure that the surviving spouse or another beneficiary will receive the income. Although statistics show that annuities can benefit a retirement portfolio, some financial planners have serious concerns about using these insurance products because of their high internal costs, their surrender charges and the big sales commissions agents make on them.