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For years, conventional wisdom has held that individuals nearing retirement should increase their fixed income allocation to protect assets and generate income.

But there are indications that view of retirement planning is changing.  Low-interest rates and longevity risk are among the factors leading investors and financial advisors to reconsider the strategies required to provide for a comfortable retirement.  New research continues to demonstrate the potential benefits of maintaining a more substantial equity position in a portfolio throughout the retirement years.

Equity exposure can provide growth across an extended retirement, but what about the need for income?  In a recent research paper (Improving Outcomes for Retirement Income Solutions by Combining Managed Money and Annuities), we examined a new approach to retirement planning using managed money and a simple annuity strategy to provide both an income stream and protection against longevity risk (this could be thought of simply as “outliving your money”).

Rising rates favor the use of annuities

Annuities are an insurance contract in which the investor provides either a lump sum or a series of payments to the insurer in return for an income stream, typically guaranteed for life. The nature of those payments is determined by a number of factors, including prevailing interest rate levels that impact the rate of return provided by the insurance company, and the life expectancy of the contraction. The internal rate of return (IRR) tends to rise (and fall) with interest rates, with higher rates resulting in a higher IRR.  As such, annuities can offer a compelling way to generate income and to protect against loss of principle during a period of declining bond prices and rising interest rates.

Annuities have long been recommended by advisors as a standalone vehicle for generating guaranteed income.  However, little research exists that examines the dynamic of combining an allocation to an annuity with managed money. In our study, we used a type of annuity known as a Single Premium Immediate Annuity (SPIA), which is typically funded with a single payment from the investor.  We examined the impact of replacing a moderate portion of an investor’s fixed income allocation with a SPIA, and the balance of the portfolio invested in a mix of stocks and bonds.  We then analyzed the results across a broad range of portfolio allocations, market conditions, longevity scenarios, and lifestyle requirements.

Among the findings:

  • Adding annuities may immunize against interest rate risk, as annuity payments tend to rise with interest rates.
  • The biggest potential benefit accrues to those who live beyond the median life expectancy, where the rate of return on the annuity generally exceeds the “risk-free” return available in the market, defined as the yield on 30-year US treasury bonds.
  • The income “guarantee” provided by the annuity may allow for a larger allocation to equities in the remaining portion of the portfolio. This, in turn, increases the likelihood of achieving the desired retirement savings outcome without increasing spending failures even in “worst case” scenarios.
  • The value of annuity allocation increased as assumed market returns fell.

Increased equity exposure can improve outcomes

When it comes to considering withdrawal rates, the so-called “4% rule” continues to dominate the planning process.  This ubiquitous rule of thumb was established in a 1994 paper by William Bengen that looked at all rolling 30-year retirement horizons starting in 1926 and a 50/50 stock (S&P 500 Total Return) and bond (Intermediate Term Government bonds) portfolio. In each starting year he computed the maximum initial portfolio withdrawal rate, that when adjusted for actual inflation each year thereafter, could have been withdrawn from the portfolio without depleting all the assets over the 30 years. In general, 4% was found to be a workable withdrawal rate for most of the periods measured.

A lot has happed in the 25 years since that study was published.  We have experienced an extended period of historically low interest rates, impacting the ability of the bond side of the portfolio to generate income.  At the same time, Individuals are living longer and often spending more years in retirement. Therefore, they need to sustain the ability to spend over longer periods of time.  As a result, researchers have taken a fresh look at the 4% rule and, in particular, its 50/50 stocks/bonds allocation.  There is a common conclusion in the withdrawal rate literature: more equity exposure typically can allow for higher rates of success.

Many investors are reluctant to increase their equity allocations in retirement, however.  The use of an SPIA in the portfolio can help alleviate these concerns by placing a floor on income, allowing spending needs to be met while providing growth through the equity portion of the portfolio.  The value of this approach is generally a function of three factors: the IRR and the subsequent income generated by the annuity, the investor’s spend rate, and longevity.

As might be expected from an insurance product, the SPIA allocation is most beneficial in non-average scenarios – greater than average life expectancy, or periods of below average returns, for example – the circumstances that most concern investors planning for or in retirement.  Critically, it may allow for higher equity allocations, the key to sustaining and growing wealth (and spending) over time.

A further concern for many investors is legacy wealth, which is not directly addressed by the 4% rule.  To measure this, we created what we call the Legacy Success Ratio, which is itself the sum of two ratios: 1) the percentage of desired spend that was actually spent over the measured periods; and, 2) the real legacy wealth left over as a fraction of the initial spend.  This can be used to measure the overall success of the plan, both in meeting spending goals and in providing for the next generation.

A few considerations

At its heart, investing is about balancing risk and reward and, as such, the portfolio construction process always involves trade-offs.

Like any insurance product, annuities provide protection against lower probability outcomes –longevity risk being the most prominent.  The insurance is not free, but it can add significant value in particular for investors who are risk averse, expect to live a long time, or are concerned about adverse market conditions or higher inflation.

The increased return scenarios are largely dependent on adding to the equity allocation, while the compounding value of equities generally assumes a multi-year investment horizon.  The equity portion can provide further benefits as well, in the form of increased liquidity for those whose spending patterns may vary over time, and potentially higher legacy wealth.

For advisors engaged in the retirement planning process, providing investors with a clear understanding of both the rewards and the risks of combining annuities and managed money across multiple scenarios is critically important.


Investors are awakening to a new reality in retirement planning.  The elimination of many traditional sources of retirement income (e.g., defined benefit plans), threats to Social Security, and growing life expectancies suggest that a re-thinking of historical planning assumptions is in order.  The results of our study show that combining SPIA with a managed money allocation can help address many of these concerns, adding value across planning horizons, different spending rates, and market types.

To download this synopsis of the white paper, click here, or download the full white paper, Improving Outcomes for Retirement Income Solutions by Combining Managed Money and Annuities, fill out the form below. To Learn more contact us Today at 866.371.2399 EXT.202 or info@horizoninvestments.com.

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