While some may argue that saving for retirement is pretty complicated, many people find it simple. You just need to set aside a part of your earnings yearly, invest for a long-time horizon, practice patience, and watch your wealth grow. When you reach retirement, you will start drawing income from your savings, and things will seem more complex. Due to this, retirees consider guaranteed income and safety of principal more important than average returns.
There are three ways of generating a safe income source in retirement:
1. Obtaining secure income from the state through Social Security or bonds.
2. Using a bank with a money market account or CD.
3. Using an insurance company through annuities or life insurance.
How Valuable are Annuities?
Researchers have, over time, have shown how annuities can add significant value to the financial security of a retiree. Here are the ways research has proved annuities to be valuable.
1. They Reduce Portfolio Failure
John Ameriks, Robert Veres, and Mark Warshawsky researched and tested the sustainability of investment portfolios.
Their research found that adding an immediate annuity into a retirement income portfolio leads to a decline in the portfolio failure rates.
The value of this cannot be understated. The risk of potentially running out of funds in retirement can be reduced by adding an annuity into a retirement income portfolio.
Their research discovered that while annuities may reduce the downside, they also could reduce the potential upside of investment gains. This means they simultaneously reduce your chance of running out of and accumulating money.
2. They Replace Bonds, SPIAs and Variable Annuities with Fixed SPIAs
Dr. Wade Pfau’s research study, ‘A Broader Framework for Determining an Efficient Frontier for Retirement Income, explored the efficient frontier of a portfolio to balance the two primary financial objectives for retirement, which is preserving the financial assets and satisfying spending goals. Dr. Wade found that a combination of stocks and fixed single premium immediate annuities made the most efficient investment mix.
This has been supported by other researchers like Roger Ibbotson.
3. They Increase Legacy
Adding annuities to your retirement income portfolio won’t reduce your legacy. According to researchers, in some cases, annuities can increase your estate and legacy. Additional research from Dr. Pfau indicates that by adding annuities to help support your lifetime spending during retirement, you may have a higher chance of meeting your spending needs, with a smaller percentage of assets. Thus, it will create a potential to allow for a larger legacy amount in the case of a longer life. The research further showed that when an annuity is added into a retirement income portfolio, true liquidity is increased.
Without an annuity, the other assets will not be available for annual spending and liquidity needs. This is because they will be invested for future income and gains. Adding an annuity into the mix can increase liquidity and spending capabilities.
Major takeaways from the research:
-Annuities bring along benefits to a retirement income plan.
-Compared to traditional safe investments, income annuities provide cheaper and more efficient income-generating ways.
-Income annuities help with longevity and portfolio failure.