Wade Pfau, Ph.D., CFA

White Paper: Reduce Retirement Costs with Deferred Income Annuities Purchased Before Retirement

Executive Summary

  • Most deferred income annuities (DIAs) have a relatively short deferral period, making them particularly appealing to clients nearing retirement who value the ability to plan on a fixed, nominal income stream after retirement.
  • Unlike long-term deferral period annuities (longevity insurance) that are primarily meant to protect against longevity risk, a short-term deferral period annuity can provide a steady income to pre-fund retirement spending over the entire retirement life cycle.
  • The purchase of a DIA before retirement is particularly valuable for clients who would have maintained a stock allocation lower than 70 percent. Retirees would have been better off without a DIA in simulations where portfolio returns are very high or when retirees die early.
  • Findings suggest that short deferral period annuities can reduce the cost of funding retirement, provide longevity protection, and offer behavioral benefits to clients concerned about near-retirement market performance.

Clients nearing retirement have increasingly been attracted to products that allow them to buy future income with recent portfolio gains. Taking assets out of a portfolio to buy a product that has a pre-defined return has important portfolio implications that should be considered by financial planners when constructing a retirement income strategy with the remaining wealth. Buying a guaranteed income also reduces risk at a time when a bear market can derail a retirement income plan.

This study uses a methodology proposed by Milevsky (2006) to evaluate the impact of guaranteed income products on the cost of funding retirement and shows when, and for which clients, a deferred income strategy makes sense.

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