Creating reliable retirement income: Evidence-based distribution strategies utilize annuities

Research by retirement experts Gaobo Pang and Mark Warshawsky demonstrates that a combined approach using both systematic withdrawals and partial annuitization typically produces superior outcomes compared to using either strategy alone. Their extensive analysis, which examined over 10,000 scenarios through sophisticated modeling, shows that allocating approximately 50% of retirement assets to a lifetime annuity while maintaining the remainder in a diversified investment portfolio for systematic withdrawals provides an optimal balance between guaranteed income and flexibility.

The researchers found this combined strategy delivered significantly better outcomes across multiple measures. When comparing different approaches, the combination strategy produced average certainty-equivalent consumption levels about 12% higher than pure systematic withdrawal approaches and 16% higher than full annuitization strategies. This translated into meaningfully higher sustainable retirement income with lower risk.

The study demonstrates that this balanced approach effectively addresses the major risks retirees face: longevity risk, market risk and inflation risk. By maintaining a significant portion in market investments while securing guaranteed income through partial annuitization, retirees can better weather various economic scenarios while maintaining spending flexibility.

The traditional "4% rule" for retirement withdrawals, while simple to understand and implement, faces significant challenges in today's environment of increased longevity and volatile markets. The research examined this approach in detail, finding that while it provides good withdrawal flexibility, it carries meaningful risks that many retirees may find uncomfortable:

• Failure rates reaching 18% by age 95, meaning nearly one in five retirees could exhaust their savings.
• Over 50% probability of depleting assets for those living past 100, a particularly concerning statistic given increasing longevity.
• High sensitivity to poor market returns in early retirement years, known as "sequence of returns risk."

Instead, the research suggests a more dynamic approach combining systematic withdrawals with guaranteed income through partial annuitization may provide better outcomes for most retirees. This approach allows for initial withdrawal rates between 5-6% while maintaining high probability of sustainability, significantly higher than the traditional 4% rule.

The research provides strong evidence that some level of annuitization benefits most retirees, but complete annuitization is rarely optimal. The study found that annuities can play several crucial roles in a retirement income strategy.

First, annuities provide mortality credits – the benefit of pooling longevity risk across many individuals – which can increase the sustainable income level compared to pure withdrawal strategies. The research shows these mortality credits become increasingly valuable as retirees age, particularly after age 75.

Second, annuities can create a personal pension-like income stream that, combined with Social Security, provides a stable foundation for retirement spending. This guaranteed income floor can allow retirees to take more appropriate investment risk with their remaining portfolio.

Third, the presence of guaranteed income from annuities can reduce the stress on the remaining investment portfolio, potentially allowing for higher equity allocations and better long-term growth potential.

The study found that health status significantly influences optimal retirement income strategies, with fascinating implications for personalized planning. Those in excellent health benefit more from higher annuitization levels due to longer life expectancy, with optimal annuitization rates typically 10-15% higher than those in average health.

Conversely, those in poor health may want to maintain greater liquidity through systematic withdrawals, though the research shows even these individuals often benefit from some level of annuitization, typically 20-30% of assets. This highlights the importance of personalizing strategies based on individual circumstances rather than applying one-size-fits-all solutions.

The SECURE Act 2.0 has dramatically improved the treatment of partial annuitization strategies. The research shows these changes provide greater flexibility in combining annuities with systematic withdrawals by:

• Reducing required minimum distributions (RMDs) by up to 76% at age 73
• Allowing aggregation of annuity payments with other distributions for RMD purposes
• Providing more favorable treatment for combination strategies
• Increasing the age for mandatory distributions to 75 by 2033

These changes make combination strategies more attractive and easier to implement, potentially encouraging more retirees to consider partial annuitization approaches.

The research demonstrates that successful retirement income planning requires careful consideration of multiple factors including:

• Investment environment. The present and expected future investment environment significantly impacts optimal strategy design. The research shows that in low-return environments, higher levels of annuitization may be appropriate, while high-return environments may favor greater allocation to systematic withdrawals.
• Individual circumstances. Health status, family longevity history and marriage status all influence optimal strategy design. Married couples, for instance, may benefit from lower initial annuitization rates with gradual increases over time.
• Legacy goals. Estate planning considerations significantly impact optimal strategy design. Those with strong bequest motives may prefer lower annuitization rates (30-40% of assets) while those focused primarily on lifetime income may opt for higher rates (50-60% of assets).
• Access to institutional pricing. The research found that access to institutional pricing for both investments and annuities through employer plans can meaningfully impact outcomes, potentially increasing sustainable income by 10-15% compared to retail pricing.
• Implementation considerations. Practical implementation aspects, such as tax efficiency and the timing of annuity purchases, can significantly impact success. The research suggests that gradual annuitization over time (laddering) can help manage interest rate risk and provide greater flexibility.

For most retirees, the evidence suggests a combined strategy using both systematic withdrawals and partial annuitization provides the most reliable path to retirement security. The research indicates this approach can increase sustainable retirement income by 15-25% compared to traditional withdrawal-only strategies while maintaining important flexibility for changing needs throughout retirement.

Key research findings highlight that personalization is essential – factors like health status, investment environment, and legacy goals all play critical roles in determining optimal strategy design. The improved treatment of partial annuitization under SECURE 2.0 makes these combination strategies more attractive and easier to implement than ever before.

Working with qualified financial professionals to implement these research-backed approaches can help create sustainable retirement income while maintaining important flexibility for changing needs throughout retirement. Regular strategy review and adjustment based on changing circumstances and market conditions remains crucial for long-term success.