Should Consumers Annuitize at Normal Retirement Age?
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
For more than a decade, researchers have been sounding the alarm that those approaching retirement face unprecedented portfolio depletion risk. Specifically, the traditional metrics applied by financial advisors to client portfolios to assess sustainability may be overly optimistic relative to the economic reality and that popular retirement spending paradigms, such as the vaunted 4% rule, put consumers at serious risk of running out of money before they run out of time.
My frequent research partner, Seattle Pacific University Professor Jack De Jong, Ph.D., CFA, MBA, and I examined this threat for ourselves in, “A Case Study in Sequence Risk: A 20-year Retrospective on the Impact of the 2000-2002 and 2007-2009 Bear Markets on Nest Egg Sustainability.” The paper was posted to SSRN in May 2021 and was published in the Journal of Wealth Management in January 2022. I summarized our findings in a June 2021 Advisor Perspectives article titled, “Be afraid, very afraid of retiring in the 2020s.” As the AP article title suggested, our conclusions largely aligned with those of prior researchers. Using monthly return data from 2000 through 2019, we illustrated that a 4% inflation-adjusted withdrawal rate applied to a classic 60:40 portfolio was in serious danger of failing well short of the standard 30-year time horizon for consumers retiring at or around normal retirement age (65).
Our findings also led us to caution that even the 2000-2001 and 2007-2008 bear markets in stocks did not represent a worst-case scenario for investors, since the dismal returns from stocks during that first decade of the 21st century were partially offset by a roaring bull market in bonds as interest rates steadily declined. Were a similar bear market in stocks to begin now and be paired with today’s near-historic low interest rates or, worse, with a prolonged period of rising interest rates (i.e., a bear market in bonds too), folks who retire in the early 2020s will be sailing into an unprecedented perfect storm of sequence risk.
With conditions ripe for an existential threat to individually managed retirement portfolios, some researchers have suggested that consumers’ desire for financial security in retirement will be better served with annuities. By pooling their risk and transferring their retirement savings to an insurance company, they will get a guaranteed lifetime stream of payments. Over the past decade, academic researchers have approached the annuitization question from many perspectives and have reached different conclusions. Drawing on a rather extensive research survey, Jack and I were inspired to explore the issue for ourselves. Our latest paper, “Is the Annuity Puzzle Really So Puzzling? An Analysis of the Consumer Lifetime Annuitization Decision in a Low Interest Rate World,” was posted to SSRN in May (2022) pending journal submission. In it, we sought to quantify the tradeoff that 65-year-old consumers make when annuitizing their retirement savings by purchasing a single-premium immediate annuity (SPIA) from an insurance company relative to managing the spending portfolio themselves. Our findings have important implications for how financial advisors should approach the annuitization decision. The purpose of this article is to share them with you.