Sat, July 16, 2011
GAO Study Recommends Delaying Social Security, Use of Immediate Annuities
One of the key risks that retirees face is the possibility of outliving their incomes. In a report released earlier this month, the US Government Accountability Office concluded that although almost 75% of retirees start taking Social Security benefits before age 65, many workers would have a significantly better chance of a successful retirement if they worked longer and waited to start collecting Social Security.
The GAO study, initiated at the request of the Senate Special Committee on Aging, was motivated by the recognition that few Americans retire with pension plan benefits. Increasingly, retirees are dependent on a combination of Social Security benefits and spending from a variety of defined-contribution savings accounts (like 401(k)s). A number of retirement studies have predicted that as many as half of Americans currently nearing retirement can be expected to run out of money before they die.
Taking Social Security early costs retirees as much as 33% in benefits that they would have received had they continued working until their full retirement ages. The GAO found that workers with less than $100,000 in retirement savings would improve their chances of a successful retirement significantly by continuing to work at least to full retirement age, if not to age 70.
The GAO cited a Congressional Research Service report that estimates the probability that a 401(k) or other defined-contribution retirement account could be made to last for a specified number of years in retirement. The study found that based on historical returns, a portfolio with a 65% stock /35% bond portfolio had an 89% chance of lasting for 35 years or more if a maximum of 4% of the account were spent each year. In practice, the degree of success depends a great deal on the portfolio’s returns in the early years of retirement. If returns in the early years are poor (as they have been over the last decade) there is a greater risk of spending down the portfolio prematurely.
The report also recommends that middle-income (defined as having a net worth of about $350K including their homes) retirees without traditional pensions could benefit from using part of their savings to purchase inflation-adjusted immediate annuities. Immediate annuities are insurance contracts that pay the contract holders a specified income, often for life.
For example, a 66 year-old couple purchasing a $100,000 inflation-adjusted immediate annuity could expect to receive about $4,440 a year in income for as long as they live. Noting that annuities are not widely used by retirees, the report explores a number of recommendations for changes in the tax code that would increase the use of annuities through conventional defined-contribution retirement plans.
The report says little about the reasons that annuities are not more widely used by retirees. One likely reason is that in return for a guaranteed stream of income, the purchase of an annuity requires giving up control of the funds and forgoing the possibility of passing them to heirs in the future. Moreover, the complexity of annuities makes some people reluctant to use them. Not all annuities are the same, and many come loaded with fees and benefits too complicated for most people to understand.
Most retirees prefer to take their chances investing their own money in hopes of doing well. Still, for many retirees, there is a case to be made for using a traditional investment portfolio in combination with an properly-chosen annuity. The two investments together behave very differently: the annuity offers reliable income that cannot be outlived, while the other financial investments hold promise of higher returns in return for higher risks and an uncertain payout.