Retirement Income Risks: Longevity, Sequence of Returns, and Stupidity

One of the first things that pops up when doing research on retirement annuities is the “annuity puzzle”. Essentially, economists have done their calculations and shown that simple, immediate income annuities are theoretically the best fit for many people. You give up some things like liquidity and upside potential, but in exchange you get the most monthly income for the rest of your life. But in the real world, only a small fraction of such people actually go out and buy such annuities.

Bob Seawright wrote a nice article at that lists three main risks with managing withdrawals from your own lump-sum portfolios. An income annuity can help address these risks. I’ve added my own comments as well.

Longevity risk. People are living longer on average. Enter your age(s) into this Vanguard longevity tool. Here is a short snippet from a previous longevity risk post:

For an individual that is 65 today, there is roughly a 50/50 chance they will reach age 80. For a couple both at 65, roughly a 50/50 chance that at least one person will reach age 90.

The extreme ages are getting higher as well; quote below taken from the Seawright post:

Moreover, the distribution of longevity is wide — a 22-year difference between the 10th and 90th percentiles of the distribution for men (dying at 70 versus 92) and a 23-year difference between the 10th and 90th percentiles of the distribution for women (dying at 72 versus 95).

Sequence of returns risk. Two retirees can start with the same initial portfolio balance and experience the same average return, but if one experiences highly negative returns in the first few years of withdrawals they can end up with very different outcomes. Here is a previous graphic illustrating the sequence of returns risk.

Stupidity risk. If you do-it-yourself, what if you aren’t very good? The idea of safe withdrawal rates is a starting point, but even that assumes a theoretical 60/40 you-didn’t-panic-when-stocks-dropped-50-percent portfolio. I like the idea of adding some robustness with more flexible dynamic safe withdrawal rates, but “safe” is still a relative term.

Eventually, I plan to put a portion of my money into a single premium immediate annuity (SPIA). I’ll probably wait until around age 65, with a joint life rider so that it will keep paying out as long as either my wife or I are alive. I like the idea of having enough guaranteed income to cover all basic needs like housing, food, and utilities. Considering that we have no mortgage and assuming no major cuts to Social Security, I am hoping that number is not too much in excess of state-specific insurance guaranty coverage limits.

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