Making the Right Wager on Client Longevity

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Using annuities to fund retirement is anathema to most advisors, who view the loss of control over one’s capital and impossibility of a bequest as nonstarters for their clients.  But as clients reach the later stages of their retirement, those arguments no longer apply.  A single-premium immediate annuity (SPIA) is superior to a TIPS ladder or a systematic-withdrawal portfolio (SWP) for funding the last phase of retirement.

Dan Moisand, a Florida-based advisor, has articulated the reasons for advisors’ antipathy toward annuities comprehensively in this article.  While his perspective is valid, it focuses primarily on retirees in their 60s.

Purchasing an SPIA is an option not only at the beginning of the retirement, but also much later. The evidence shows that in the last phase of retirement, using a SWP is a bad wager – and the wrong advice for a fiduciary advisor to give. Indeed, the very same reasons SPIA detractors use to argue that they are wrong for new retirees in their 60s explain an SPIA’s value later in life.

Let’s look first at an 85-year old retiree and compare an SPIA to a TIPS ladder and a SWP strategy.  We will see that the SPIA generates superior income – and also leads to larger bequests.

The analysis that follows came from Monte Carlo simulation using Income Discovery, the software that my firm developed for analyzing retirement income strategies. 

Comparing strategies for an 85-year old retiree

Let’s consider a single 65-year-old male planning a 30-year retirement. Instead of focusing on the income strategies for when he retires, we’ll fast-forward 20 years and consider how he can generate income for the last 10 years of the 30-year plan, examining specifically the three strategies mentioned above: relying on an SWP, relying primarily on a TIPS ladder, or getting all of the income from an SPIA. I considered a TIPS ladder because, for time horizons as short as 10 years, the short-term volatility of the SWP makes it an inefficient strategy to fund the income need – as I explained in my last article in this publication.

The hypothetical retiree is getting $30,000 of Social Security income and needs to generate an additional $22,500 from his portfolio. I determined that the amount of assets required to produce $22,500 of income using two strategies.  First, I examined a SWP with a 98% probability of success using a moderate allocation (60% large-cap stocks and 40% intermediate-term government bonds). Second, I considered a TIPS ladder that provides 95% of the desired income over an eight-year period1 and a SWP to provide the balance.

I used historical monthly inflation data and monthly asset-class real returns, based on Ibbotson data from 1926-2010.2 Annually rebalanced SWP simulation used real returns, after withdrawing real income of $22,500. The first year's income need was withdrawn from the SWP before the initial investment. This approach of withdrawing income up front means only nine years of returns are needed to simulate the SWP. The TIPS ladder also provided its cash flow beginning in the second year.3 

The table below presents the minimum assets needed for each strategy to generate $22,500 of income with a 98% probability of success. I also present the assets needed to generate the same income from a SPIA that adjusts its payout based on CPI-U index. The payout rate from this annuity is 13.5% for an 85-year old male.4


Minimum assets for 98% confidence

Equivalent Safe Withdrawal Rate for 10 years

Moderate SWP



TIPS Ladder



Inflation-adjusted SPIA



1. The TIPS ladder is constructed using actual bonds. The cash flow produced by the ladder may be approximately $1,000 higher than desired, as it is not possible to buy a fraction of a bond. The TIPS ladder is configured to provide 95% of the cash flow to avoid the situation of generating more cash flow than desired. The length of TIPS ladder is eighth years for two reasons: (1) the first withdrawal is made at the beginning of the plan (January 2013) and hence is taken from the SWP assets and not from the ladder; (2) no TIPS are available for the 10th year disbursal in January 2022. TIPS inventory and quotes as of Apr 19, 2012 have been used.

2. Annual inflation and real asset class returns were generated from the monthly data. Although the period of analysis is 10 years, a standard 30-year rolling period-based scenario set was used to maintain consistency with prior research that uses rolling 30 year historical windows. The last scenario path of that set begins in January 1981. If 10 year rolling windows were used, then additional scenario paths could have been generated. For the simulation, returns from the initial years of each scenario path were used for the analysis.

3. For the sake of brevity, I’m not including the exhaustive details of constructing and determining cash flow from the TIPS ladder under different inflation and deflation scenarios. The Income Discovery methodology document provides those details.

4. The annuity quote was obtained from Income Solutions®, an annuity purchase program from Hueler Investment Services. INCOME SOLUTIONS® is a registered trademark of Hueler Investment Services, Inc.  U.S. Patent 7,653,560