Combining SPIAs and Smoothing to Improve Retirement Outcomes

I’ve previously written articles about two separate techniques for improving retirement outcomes: the use of single-premium immediate annuities (SPIAs) and smoothing of year-to-year withdrawals. In this article I investigate ways to combine SPIAs and smoothing to produce even better outcomes. I’ll then broaden the discussion and briefly explain how SPIAs and smoothing fit into the wider context of ways to improve retirement outcomes.

Using a hypothetical client example, I’ll first show the effects of smoothing without using SPIAs, next introduce SPIAs and then circle back to test different smoothing approaches combined with SPIAs. I’ll base my modeling on a variable withdrawal approach (described in detail in the Appendix) that each year recalculates withdrawals with an aim of smoothing consumption over expected remaining life.

This example will be based on a 65-year-old retired female with a remaining life expectancy of 25 years and $1 million in savings split 50/50 stocks/bonds that she can dedicate to generating retirement income. (She has separate funds for unanticipated expenses.) Her basic living expenses are $50,000 per year, increasing with inflation, and she will receive an inflation-adjusted $30,000 annually from Social Security. She will utilize withdrawals from savings to cover the gap between basic living expenses and guaranteed lifetime income and take additional withdrawals for discretionary spending. Her main goal is to generate sustainable retirement income; leaving a bequest is of secondary importance. The analysis will be pre-tax.

To simplify the presentation, I’ll show a single case before-and-after comparison in each chart rather than comparing arrays of outcomes. I’ve done behind-the-scenes testing to determine the most appropriate results to display.

Impact of smoothing

In this May 2015 Advisor Perspectives article, I discussed the impact of smoothing year-to-year withdrawals. I wrote the article partly in response to an Advisor Perspectives article by Laurence Siegel where he proposed the ARVA (annually recalculated virtual annuity) approach for determining retirement withdrawals and spending. In his article, he argued against attempts at smoothing other than by lowering the stock allocation to reduce investment volatility. I demonstrated that an argument could be made for smoothing techniques such as averaging portfolio returns over multiple years rather than recognizing each year’s return on its own. However, in deference to Siegel, my research did indicate that multiple-year averaging did have negatives as well as positives as I show in the comparison below.