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Dispatches

Which Is Better: 4% Withdrawals or Annuities?

TIAA Institute compared systematic withdrawals against annuitizing in retirement.

Among the options available to retirees is to take systematic withdrawals from their portfolios or to purchase annuities.

A systematic withdrawal—the most commonly used is the 4% rule—involves taking a specific percentage of retirement savings during the first year (e.g., 4%) and increasing the amount withdrawn in accordance with inflation. Annuities pay a stream of income and transfer the risk of outliving savings from the retiree to the insurance company.

So which is better? TIAA Institute compared systematic withdrawals against annuitizing. Their conclusion was to do both: Put half of savings into a variable annuity and fulfill any additional income needs by taking systematic withdrawals from a stock and bond portfolio. They found that this provided the best mixture of both income and ending wealth.

The study considered three strategies: a guaranteed lifetime income product (GLWB), a hybrid strategy combining a variable annuity with supplementary systematic withdrawals and a purely systematic withdrawal strategy.

A guaranteed lifetime income product guarantees a minimum level of lifetime income. Though payments cannot drop below a certain level, the account balance must rise above a certain threshold for the payment to increase. Fees on the GLWB make crossing the minimum threshold more difficult, limiting this product’s appeal.

The systematic withdrawal strategy gives the retiree the most flexibility and control. It also gives access to savings should an emergency occur. The risks of outliving savings and poor market returns, however, are completely borne by the retiree.

A variable annuity’s (VIA) payments vary depending on the returns of the investments underlying the contract. A downside to a variable annuity is the possibility of income being reduced both in inflation-adjusted and absolute dollars. Combining a VIA with a systematic withdrawal offsets some of these risks. Systematic or periodic withdrawals can be taken from the separate investment portfolio to supplement income from the VIA. The risk of a long life is borne by the insurance company, while the investor has the upside of being able to tap portfolio savings should an emergency arise.

Source: “Achieving Retirement Income Security,” Benjamin Goodman and David Richardson, TIAA Institute Research Dialogue, May 2016.

Discussion

Rob from Hawaii posted over 10 years ago:

This is helpful, but I'm puzzled why the illustration uses a variable annuity instead of an immediate annuity. If the point is to diversify the retiree's risk, then an immediate annuity would seem preferable to a VIA. Am I missing something?


Roy Goern from NV posted over 10 years ago:

Good question. Any answer?


Arthur Spangler from MA posted over 10 years ago:

The study was on a Variable Immediate Annuity (VIA).


Mike from IL posted over 10 years ago:

And the "variable" part of a VIA is to offer the annuitant some degree of inflation protection


Fred J. Tantillo from NY posted over 10 years ago:

The benefit of using an annuity to provide retirement income is to mitigate longevity risk. The internal expenses of the VIA could reduce the contracts ability to provide the rising income needed to combat inflation. The immediate annuity should provide a higher initial income and look to the systematic withdrawals to provide the inflation protection.


William Deshurko from OH posted over 10 years ago:

As an investment advisor that could sell variable annuities and make really nice commissions, I can emphatically say that the expenses of a VA with a guaranteed income benefit are not worth it. Manage a portfolio of dividend paying stocks - combination of high yielders and dividend raisers and you have a low cost increasing stream of income that will last forever. Key is living off of dividends only.


Harry Peters from MT posted over 10 years ago:

W. Deshurko: Great comment and summary of a viable, financially robust alternative. TIAA would certainly infuse their bias since their TIAA-CREF organization is a major provider of annuities.


Dave Gilmer from WA posted over 10 years ago:

What you also must, or at least should, consider is how much of your current retirement income is already covered by guaranteed annuity type sources such as Social Security and Pensions. Since the VIA is a rather expensive form of risk reduction, if you don't need it, there is more of a reason to just reduce your risk in your own investments than to pay for more insurance.


aaii.comp.rk from NEW JERSEY posted over 10 years ago:

Annuity is paycheck for wealth management industry, variable, double-life or anything else. for very conservative: 20 to 30% in Money Market funds to cover market meltdowns. REST into dividend paying ETFS with low cost management fee. There are many dividend paying ETFs including DVY,SDIV,VANGUARDs many income generating dividend friends and you do not have to fund someone else. INTL REIT GOV OFFICe REIT REGULAR REIT no single stocks. I have considered adding DODFX a mutual fund. I would like to include a fixed income fund which bears coupon, never sells bonds before maturity. they all appear to churn and so I do not advocate allocation to fixed income at this time. These are equity based and are perpetual. Make sure there is no fine print authorizing firms to annuitize automatically. If you start early with DRIP, sky is the limit. regards Raman


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