MW Deferred annuities are better deals than immediate annuities

By Mark Hulbert

A better way of securing a guaranteed lifetime income

Not only does the early bird get the worm, he gets a higher annuity payout as well.

That's the finding of a new study that the National Bureau of Economic Research began circulating earlier this month. Entitled "Target Retirement Fund: A Variant on Target Date Funds That Uses Deferred Life Annuities Rather than Bonds to Reduce Risk in Retirement," the study was conducted by John Shoven, an economics professor at Stanford University, and Daniel Walton, a data scientist at Uber Technologies.

The researchers constructed a hypothetical Target Retirement Portfolio $(TRF)$ that, like a traditional target date fund $(TDF)$, gradually reduces its equity exposure beginning at the age of 50. But instead of investing the proceeds of these equity sales in bonds, the researchers invested them instead in deferred annuities that begin their monthly guaranteed payments at age 65. They then calculated how much it would cost for the traditional TDF, at age 65, to purchase a single annuity that produces the equivalent monthly payout as the TRF's annuity ladder.

At this point the two portfolios produce the same monthly annuity payout, and their only difference will be how much the rest of their portfolios are worth. The researchers ran hundreds of simulations based on historical returns on stocks, bonds, and Treasury interest rates, and found that in nearly 90% of the cases their hypothetical TRF portfolio had significantly more non-annuity assets than the TDF.

In other words, you get a lot more annuity bang for your buck if you buy annuities in stages over the years prior to when you would otherwise purchase a single annuity.

Is there a catch with the annuity ladder approach? Perhaps, Shoven said in an interview, though you may not consider it a deal breaker: If you die between ages 50 and 65, you will receive nothing in return for what you invested in the annuities. Fortunately, the odds of a 50-year-old dying before reaching 65 are very low.

You may also object to the annuity ladder approach on the grounds that it reduces what otherwise might be available to your heirs. But Shoven pointed out that their simulations focus on a retiree who otherwise purchases an annuity at age 65. The issue their research addresses is not whether to invest in an annuity, but instead whether to do so in one fell swoop at age 65 or in stages beginning at age 50.

What was the source of the superior returns of the researchers' TRF portfolio? They identify two:

The bottom line? If you were already considering the purchase of an annuity when you retire, consider purchasing instead a series of annuities in stages beginning at age 50. By doing that you very likely will increase the amount you will have to live on during retirement.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com.

-Mark Hulbert

(END) Dow Jones Newswires

January 20, 2023 14:16 ET (19:16 GMT)

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