Pairing the most plain-vanilla type of annuity—called a
single-premium immediate annuity—with stocks, retirees can generate income more
safely and reliably than if they use bonds for that piece of their portfolio,
says Wade Pfau, a professor who researches retirement income.
To arrive at that conclusion, he plotted how 1,001 different
product allocations might work for a 65-year-old married couple hoping to
generate 4% annual income from their portfolio.
Using 200 Monte Carlo simulations for each product
allocation, and assuming returns based on current market conditions, the
winning combination turns out to be a 50/50 mix of stocks and fixed annuities,
Mr. Pfau says. If inflation accelerates more than the markets now expect,
inflation-adjusted annuities would become more attractive, he adds.
"There is no need for retirees to hold bonds," he
says. Instead, annuities, with their promise of income for life, act like
"super bonds with no maturity dates," he says.
But immediate annuities have one big drawback: The buyer
loses access to his or her savings in exchange for those guaranteed payments.
In other words, if you have a sudden long-term-care need or some other type of
emergency, there's no way to recapture a large chunk of cash. As a result, some
retirees and their advisers are using variable annuities with guaranteed income
benefits instead. These annuities allow
investors to withdraw more than the set annual amount in an emergency.
Mark Cortazzo, a certified financial planner, typically
recommends that people preparing to retire figure out their basic,
nondiscretionary annual expenses and use a variable annuity with guaranteed
benefits to make up for whatever portion of that total won't be covered by Canada
Pension Plan, Old Age Security, and any pensions. That way, they can pay their
bills throughout retirement and afford the risk of investing much of the rest
of their savings in stock funds, he says.
"If they've got a guaranteed cheque that's covering
their needs, it's a lot easier for them to stick it out when there's a storm
coming" in the stock market, Mr. Cortazzo says.