© 2008 morningstar, inc. all rights reserved. 3/1/2008 lcn200803-2013997 role of immediate...

© 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


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


20

40

60

$80k Annual payment

65 years old 70 75 80 85 90 95 100


Simulated Immediate Variable Annuity Term PaymentsInflation-adjusted payments with 15-year payout option


$100k Annual withdrawal payment (real dollars)

80

60

40

20

0

65 years old 70 75 80 85 90 95 100

• 50% confidence level



Simulation of Systematic Withdrawals and AnnuitizationIncome level with 50% systematic withdrawal and 50% immediate variable annuitization



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



Wealth (today’s dollars)

Income (today’s dollars)

Retirement Portfolios With Immediate Payout AnnuitiesSimulated probabilities for a moderate risk annuitized portfolio


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)


Immediate Annuities May Lessen Income GapPercent of target income met assuming 5% withdrawal rate (90% confidence level)


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


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

© 2008 morningstar, inc. all rights reserved. 3/1/2008 lcn200803-2013997 role of immediate...

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