During a recent webinar hosted by TIAA, Benjamin Goodman, a vice president and actuary with the firm, emphasized an important but often overlooked fact about annuities.
Looking at the last 40 or 50 years of market history, an investor who purchased a pure variable annuity would have kept pace with inflation over the long run, although the individual might have experienced reductions in actual income in a given year, he said. On the other hand, Goodman explained, even though the TIAA Traditional fixed annuity has a history of giving raises, those raises have not actually kept pace with inflation during this time period, and the same is true of virtually all similar fixed annuity products.
Goodman said this set of facts should be considered carefully as the retirement planning industry grapples with the “decumulation challenge,” i.e., the effort to create an ecosystem of solutions and services that will help defined contribution (DC) plan participants sustainably spend down their assets during retirement. The key lesson, Goodman said, is to see how a strategy of using fixed and variable annuities as the anchor of lifetime income, complemented with other investments and withdrawal options, can promote greater potential growth and more sustainable income during a long retirement.
Combining Annuity Types
“In-plan variable annuities complement other income sources, such as Social Security, with their potential to provide increased income during favorable market periods,” Goodman said. “Our research shows the three challenges of living longer, facing market volatility and potentially experiencing cognitive decline can also significantly impact retirement success and income sufficiency. A portfolio diversified with fixed and variable annuities helps mitigate the downsides of these risks.”
David Blanchett, head of retirement research at Morningstar Investment Management, recently conducted an analysis on this exact topic, and he joined Goodman on the TIAA webcast.
“While each source of income has its own risks, combining them can help manage the risk of each and create better outcomes,” Blanchett explained.
In basic terms, owning fixed annuities creates the floor of guaranteed lifetime income—with certainty about the amount of income that will be paid out for life. In turn, adding variable annuities to the portfolio also provides guaranteed income, adding to the floor established via the fixed annuities. The variable payments from this part of the portfolio will fluctuate alongside market performance, and, in the end, as the markets grow over the long term, the investor benefits from having access to this growth. Throughout their retirement journey, an individual with both types of annuities can have certainty about not falling below a necessary income level.
The Behavioral Standpoint
This approach makes sense from not only an economic/actuarial standpoint, Goodman and Blanchett said. It also helps to create a sense of certainty and confidence among retirees—a precious commodity indeed. The pair said TIAA and Morningstar research shows investors broadly fear, and are often seriously harmed by, market volatility that occurs during the first few years of retirement. A blend of fixed and variable annuities that begin payments immediately upon retirement permits people to avoid liquidating equity holdings during market drops.
To be clear, the two guaranteed income components will not and should not make up an entire retirement portfolio. The typical retiree will also need to hold substantial investments in a liquid portfolio that is invested in the equity markets, Goodman and Blanchett said. In fact, with the dependability of receiving lifetime income from annuities, retirees may choose to be more aggressive with other parts of their portfolios.
In essence, if investors are less concerned about the risk of market volatility, they likely will have greater confidence that they can meet their everyday expenses with income that lasts a lifetime.