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© 2008 Morningstar, Inc. All rights reserved. 3/1/2008LCN200803-2013997
Role of Immediate Annuities in Retirement
Retirees Should Plan for a Long RetirementProbability of a 65-year-old living to various ages
Source: Annuity 2000 Mortality Tables. © 2008 Morningstar, Inc. All rights reserved. 3/1/2008
0
25
50
75
100%
65 years old 70 75 80 85 90 95 100 105
• Male
• Female
• At least one spouse
78 86
85 91
91 96
81
88
93
Personal Savings Expected to Play a Larger Role in RetirementSurvey of retirement income sources
Source: Employee Benefit Research Institute, 2007 Retirement Confidence Survey. Data presented in 2007 Retirement Confidence Survey may not total 100 due to rounding and/or missing categories. © 2008 Morningstar, Inc. All rights reserved. 3/1/2008
Today’s workers(Expected sources of retirement income)
Today’s retirees(Actual sources of income)
• Social Security
• Pension plans
• Personal savings/other
40%
21%
37%
71%
14%
13%
Potential Shortfall: The Risk of High Withdrawal RatesAnnual inflation-adjusted withdrawal as a % of initial portfolio wealth
Past performance is no guarantee of future results. Hypothetical value of $500,000 invested at the beginning of 1973. Portfolio: 50% large stocks/50% intermediate-term bonds. Assumes reinvestment of income and no transaction costs or taxes. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2008 Morningstar, Inc. All rights reserved. 3/1/2008
$500k
400
300
200
100
0
1973 1975 1980 1985 1990 1995
5%6%7%8%9%Withdrawal rate:
What is an Immediate Payout Annuity?
© 2008 Morningstar, Inc. All rights reserved. 3/1/2008
An insurance product designed to protect against outliving one’s assets Payable for the life of annuitant or over a specified period
Fixed payout annuity A series of payments fixed in amount
Variable payout annuity A series of variable payments based on the investment performance
of a separate account
Inflation Affects Immediate Fixed Annuity PaymentsPayment stream in real dollars from a $1,000,000 premium fixed annuity
Assumes a 65-year-old male living in Illinois and a $1,000,000 premium. Estimated annual payments are $80,640 adjusted for inflation of 3.1%. Quote obtained from www.immediateannuities.com. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. Past performance is no guarantee of future results. © 2008 Morningstar, Inc. All rights reserved. 3/1/2008
20
40
60
80
$100k Annual payment
65 years old 70 75 80 85 90 95 100
• Fixed annuity payments (after inflation)• Fixed annuity payments
Discussion of Simulation Criteria and Methodology
© 2008 Morningstar, Inc. All rights reserved. 3/1/2008
Many of the following images were created using parametric simulation. This model estimates the range of possible outcomes based on a set of assumptions including arithmetic mean (return), standard deviation (risk), and correlation for a set of asset classes. The inputs used herein are the historical 1926–2007 figures. The risk and return of each asset class, cross-correlation, and annual average inflation over this time period follow. Stocks: risk 20.0%, return 12.3%; Bonds: risk 5.7%, return 5.5%; Correlation 0.04; Inflation: return 3.1%.
Note that other investments not considered may have characteristics similar or superior to those being analyzed. Each simulation produces 35 randomly selected return estimates consistent with the characteristics of the portfolio to estimate the return distribution over a 35-year period. Each simulation is run 5,000 times, to give 5,000 possible 35-year scenarios. A limitation of the simulation model is that it assumes that the distribution of returns is normal. Should actual returns not follow this pattern, results may vary.
Interpreting Confidence Levels in Simulation
This table is intended to help interpret 50%, 75%, and 90% confidence levels illustrated in the following images. © 2008 Morningstar, Inc. All rights reserved. 3/1/2008
50%
75%
90%(More conservative)
50%
75%
90%
25%
10%
50%
Confidence level Chance of exceeding Chance of falling short
Simulation Can Illustrate the Probability of Achieving OutcomesA visual interpretation of confidence levels in simulation
IMPORTANT: Projections generated by Morningstar regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary over time and with each simulation. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2008 Morningstar, Inc. 3/1/2008
$10 mil
1 mil
100k
10k
65 Years old 70 75 80 85 90 95 100
• 50% confidence level• 75% confidence level• 90% confidence level
Simulated Immediate Variable Annuity PaymentsInflation-adjusted payments with life only payout option
IMPORTANT: Projections generated by Morningstar regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary over time and with each simulation. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2008 Morningstar, Inc. 3/1/2008
20
40
60
$80k Annual payment
65 years old 70 75 80 85 90 95 100
• 50% confidence level• 75% confidence level• 90% confidence level
Simulated Immediate Variable Annuity Term PaymentsInflation-adjusted payments with 15-year payout option
IMPORTANT: Projections generated by Morningstar regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary over time and with each simulation. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2008 Morningstar, Inc. 3/1/2008
$100k Annual withdrawal payment (real dollars)
80
60
40
20
0
65 years old 70 75 80 85 90 95 100
• 50% confidence level
• 75% confidence level
• 90% confidence level
Simulation of Systematic Withdrawals and AnnuitizationIncome level with 50% systematic withdrawal and 50% immediate variable annuitization
IMPORTANT: Projections generated by Morningstar regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary over time and with each simulation. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2008 Morningstar, Inc. 3/1/2008
• 50% confidence level• 75% confidence level• 90% confidence level
0
20
40
60
80
$100k Annual payment
65 years old 70 75 80 85 90 95 100
Sample Allocations With and Without Immediate Payout AnnuitiesModerate bequest desire
These allocations will be used in many of the following illustrations. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. Past performance is no guarantee of future results. © 2008 Morningstar, Inc. All rights reserved. 3/1/2008
Traditional portfolios
Annuitized portfolios
Conservative Moderate Aggressive
Conservative Moderate Aggressive
10%
90%
40%
60%100%
2%
8%
24%
66%
46%
13%
27%
14%
28%
72%
• Stocks• Bonds• Fixed annuities• Variable annuities
46%
0
20
40
$60k
100k
10
$1 mil
65 years old 70 75 80 85 90 95 100
Retirement Portfolios Without Payout AnnuitiesSimulated probabilities for a moderate risk traditional portfolio
IMPORTANT: Projections generated by Morningstar regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary over time and with each simulation. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2008 Morningstar, Inc. 3/1/2008
• 50% confidence level• 75% confidence level• 90% confidence level
Wealth (today’s dollars)
Income (today’s dollars)
Retirement Portfolios With Immediate Payout AnnuitiesSimulated probabilities for a moderate risk annuitized portfolio
IMPORTANT: Projections generated by Morningstar regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary over time and with each simulation. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2008 Morningstar, Inc. 3/1/2008
0
20
40
$60k
100k
10
$1 mil
65 years old 70 75 80 85 90 95 100
Wealth (today’s dollars)
Income (today’s dollars)
• 50% confidence level• 75% confidence level• 90% confidence level
Immediate Annuities May Lessen Income GapPercent of target income met assuming 5% withdrawal rate (90% confidence level)
IMPORTANT: Projections generated by Morningstar regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary over time and with each simulation. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2008 Morningstar, Inc. 3/1/2008
With annuitiesWith annuities
Aggressive risk profile
Moderate
Conservative
No annuitiesNo annuities
Aggressive risk profile
Moderate
Conservative
Age 80 85 90 10095
Age 80 85 90 10095
100%
100%
100%
79%
100%
0%
0%
0%
0%
0%
0%
0%
0%
0%
0%
100%
100%
100%
44%
100%
100%
26%
24%
20%
23%
20%
17%
23%
17%
14%
Since both the withdrawal rate and the results are in percentage terms, the results illustrated apply to any beginning portfolio valueand income need. For example, a starting portfolio of $1 million with 5% initial withdrawal (=$50,000) is expected to produce 26% of its income target by age 90, if annuitized into an aggressive portfolio.
Assessing Suitability of Immediate Annuities in an Asset Allocation
© 2008 Morningstar, Inc. All rights reserved. 3/1/2008
Immediateannuities
Factor Reason
Age increases
Higher wealth consumption
Increased subjective survival (a perception of better than average health)
Greater apprehension about turning over money to purchase annuity
Greater bequest (a desire to leave an estate)
Higher fees
Greater wealth
More sources of guaranteed income (Social Security, pensions)
Mortality credit
Preference to consume wealth
Long personal life expectancy requires portfolio protection
Decision to annuitize is irreversible or permanent
Want to leave more to heirs
Fees reduce returns
Wealthy less likely to need income guarantees
Smaller income gaps (less need for guaranteed sources of income from other sources)
Less suitableMore suitable