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Annuities: Now, later, never?
Old 10-30-2006, 09:08 AM   #1
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Annuities: Now, later, never?

From TIAA-CREF's research institute:

Annuities: Now, later, never?

The article focuses on immediate payout fixed and variable annuities.

With the growing prominence of defined contribution plans as primary retirement funding vehicles, there is a concern that participants should be making appropriate decisions in drawing income from their account balances. One major question relates to the role of life annuities as an effective means of receiving retirement income. This paper examines the financial efficacy of receiving income through a life annuity versus systematic withdrawals from a participant's account. As a basis for comparison, we contrast the receipt of life annuity income to equivalent withdrawals made from an investment account, assuming that both the life annuity income and the investment account earnings reflect the same investment return (net of expenses). This form of comparison is done for both a typical fixed annuity and for a variable life annuity. Based on hypothetical future investment earnings rates, these illustrations show that the individual who utilizes systematic withdrawal is projected to run out of funds some time before reaching his or her life expectancy. In other words, there is more than a 50% chance that the individual would run out of money!

This comparison is then repeated for the variable life annuity, but this time based on actual S&P 500 investment experience over two different time periods: 1965 - 1989 and 1975 - 1999. Using real investment experience, we again see that, had an individual withdrawn (systematically) the same income as would have been payable from a variable life annuity, that individual would have run out of money before reaching his or her life expectancy. In other words, whether we use hypothetical or real investment experience, a comparison of life annuities versus systematic withdrawals (of equivalent amounts) demonstrates the financial efficacy of annuitization. Put another way, one can say that a life annuity is financially engineered to maximize the amount of living income to an individual.
Having demonstrated the value of utilizing a life annuity, we then go on to examine the efficacy of delaying the start of annuity income to a later age. Using examples based on both fixed and variable annuities, we show that the cost for delaying annuitization by five years (assuming a retirement age of 65) is about a 5% reduction in future income, while a delay of ten years might result in a 15% reduction in lifetime income. Itís also noted that these relative reductions would be smaller in respect to individuals who retire at earlier ages. Still, while some people might feel that a 5% income reduction might be a fair trade for being given an extra five years to decide whether or not to annuitize (during whichtime certain health issues may arise), there is clearly much less value in waiting ten years or more.

The paper also explores the potential impact on income if individuals postpone annuitization during a period of rising interest rates. Assuming interest rates rise by 0.25% each year, a five-year delay in annuitization results in a 7% gain in income. However, the latter result reflects the assumption that interest rates are the same both in the accumulation and annuity payout stage. In reality, some companies may use higher interest rates in their payout annuities, to reflect the higher rates generally associated with long-term fixed-income investments. If payout annuity interest rates are, indeed, higher than accumulating interest rates, the value of deferring annuitization may be lessened, unless interest rates rise significantly over a relatively short time period. Finally, we point out that the issue of postponing annuitization in a rising interest rate environment has no relevance to variable life annuities, as income under the latter type of annuity is always adjusted by the investment experience of the underlying assets.
The article mainly focuses on persons that are 65+ and trying to decide whether and when to annuitize money. However, the article does give a nod to early retirees:

Itís important to note that the relative impact of delaying annuitization is more related to age than to the number of years of delay. If we considered the impact on a 55-year-old retiree, we would see that a 5-year delay (from ages 55 to 60) would only result in a 2% cut in future income, while a 10-year delay would reduce future life annuity income by about 6%. In essence, there is a much greater reduction in future income associated with postponement of annuitization past age 70 as opposed to postponement at earlier ages.
- Alec

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Re: Annuities: Now, later, never?
Old 10-30-2006, 11:02 AM   #2
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Re: Annuities: Now, later, never?

Originally Posted by ats5g
The article mainly focuses on persons that are 65+ and trying to decide whether and when to annuitize money. However, the article does give a nod to early retirees:

- Alec
I think the biggest factor in delaying is the prospect of new medical conditions developing before you apply.
For the fun of it...Keith
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