Using Annuities to Increase Predictable Income in Retirement

The management of a distribution portfolio is unique and should be designed differently from the management of an accumulation portfolio. However, complex distribution planning is still a developing area within the arena of Financial Planning. After focusing much of your investment lifetime on maximizing wealth accumulation through contributions and rates of return, your attention must shift entirely towards generating a sustainable income level for an indefinite period – the remainder of your life. Keeping this in mind, let’s look at some of the ways that income annuities can be used to complement fixed income (bond funds) as a portion of the product allocation of your retirement portfolio.

The Role of an Income Annuity in a Retirement Cash Flow Plan

There are two key principles that we believe should guide the use of income annuities in place of bonds and bond funds in a retiree’s portfolio. First, you should try to cover as much of your essential expenses (utilities, food, healthcare, etc.) as possible with guaranteed income sources such as Social Security, pension benefits, and income annuities. The greater the portion of your desired spending level that is

covered through “secured income sources,” the greater your ability to use systematic withdrawals from your investment portfolio (fluctuating income) to help cover discretionary spending (hobbies, vacations, etc.).


Fidelity Brokerage Services LLC. (2020, September 30). Components of a diversified retirement income strategy [Image]. Fidelity.

The second important principle is creating your retirement income stream through a combination of varied sources (product diversification), similar to the way that you have propagated your investments

(asset diversification) during your wealth accumulation years. Using an income annuity as one of

multiple sources for generating retirement income can help mitigate the following:

Market Risk/Interest Rate Risk

As previously mentioned, the primary focus of a retirement portfolio is to generate an indefinite, sustainable income stream. The greater the substitution of income annuities for the bond allocation of a portfolio, the more interest rate risk is reduced while simultaneously securing a percentage of the desired income level. Rising interest rates will lead to falling bond prices and may force a retiree to lock in capital losses, as assets will need to be sold to satisfy their cash flow objectives. A rising interest rate environment, which we will inevitably experience, would pose no risk to the income annuity allocation of a retiree’s portfolio.

Longevity Risk

Income annuities provide longevity protection, which is unattainable with fixed income investing through traditional bonds or bond funds. Income annuities can provide income for an indefinite period (single or joint lifetimes) but trying to meet spending objectives solely using bonds or bond funds will certainly result in portfolio depletion.

With income annuities, the issuing insurance company invests the capital primarily in a fixed income portfolio of funds and can therefore be considered a reasonable substitute for the retiree’s bond allocation. However, the insurance companies that issue income annuities can use a risk-pooling feature that can provide the retiree with something traditional bonds or bond funds cannot – mortality credits. Individuals that end up experiencing short retirements will subsidize the income stream of those that will experience extended retirements. This concept is known as “longevity protection.”

Why Annuitize a Portion of Retirement Capital?

Guaranteed income products, such as deferred or immediate income annuities, serve a specific purpose for retirees. They transfer risks that are unique to a retirement portfolio’s interest rate/market risk and longevity risk from the retiree to the issuing insurance company. These products are designed for individuals seeking to trade growth potential for a guaranteed lifetime income stream; this should be the paradigm shift of a new retiree’s thought process. Like any investment product, they are not right for everyone, and part of the tradeoff is giving up some flexibility (liquidity), which is why it is better to substitute a portion of your bond allocation rather than all of it. Also, note that annuity payments are based upon the financial strength rating and claims paying ability of the insurer. However, life offers few guarantees, particularly when it comes to personal finances. The peace of mind that comes with knowing that you will have sufficient income that you will not outlive and can rely on may be well worth the tradeoff.

At Waterford Advisors, LLC we are developing expertise that involves incorporating income annuities into our clients’ Retirement Cash Flow plans. The financial metrics we are hoping to improve through utilization of this strategy include a reduction of the average withdrawal rate on the retiree’s portfolio as well as an increase to the retiree’s funded ratio (present value of cumulative assets as a portion of total liabilities). As a result, this should also increase the retiree’s retirement sustainability quotient (the probability that they do not run out of funds before they run out of time). If you would like to inquire about this, please feel free to contact our office.