Page 14 - Investment Advisor February/March 2023

ANNUITIES UPDATE

By John Manganaro

What if TDFs Used Annuities?

New research suggests target date funds could be improved by
incorporating periodic annuity purchases as investors approach retirement.

new paper published by the the savings effort, and it then devotes
National Bureau of Economic 10% of accumulated assets to the pur-
A Research evaluates a proposed chase of a deferred life annuity at 50, 52,
variant of the popular target date 54, 56, 58, 60 and 62.
fund vehicle used in employer-sponsored Each of these seven purchases redi-
retirement savings plans, with the goal of rects 10% of the accumulated equity bal-
determining whether redirecting alloca- ance to a deferred annuity at the time of
tions from bonds to deferred income purchase. To determine the price of the
annuities boosts participant outcomes. annuities, the researchers used online
The analysis was put together by John quotations from a well-known annuity
Shoven of the Department of Economics pricing service.
at Stanford University and Daniel Other key inputs are the fact that
Walton of Uber Technologies (former- the theoretical participant contributes
ly with Stanford University). The duo thanks in large part to the use of TDFs 9% of salary starting at age 35, and the
asks what would happen if, rather than by employers as a default investment employee retires on their 65th birthday,
increasing the allocation to bond funds option. As of year-end 2019, 60% of with each of the deferred annuity pay-
as retirement approaches, a TDF instead 401(k) participants had at least some ment streams commencing at 65. The
gradually purchased deferred life annui- money in a TDF, while 87% of 401(k) model utilizes 1,000 possible 30-year
ties beginning at age 50. plans offered TDFs. futures for stock returns, bond fund
In the particular straw model target As Shoven and Walton point out, the returns and Treasury interest rates.
retirement fund examined in the paper, distinguishing feature of TDFs is the
the defined contribution participant provision of a dynamic asset allocation PROMISING RESULTS
makes deferred life annuity purchases that depends on only one thing — the According to the authors, the general
at ages 50, 52, 54, 56, 58, 60 and 62. participant’s age. As such, TDFs are result of this analysis strongly supports
Ultimately, the analysis compares offered with a range of target retirement the proposition that buying annuities
how this participant would fare com- dates such as 2020, 2025, 2030, 2035, starting at age 50 is superior to wait-
pared with someone who stays with a going all the way to 2065. ing until retirement at 65, at least in
traditional TDF until retirement and In funds with a more distant tar- the large majority of future return sce-
only then buys an immediate life annui- get date, such as 2045 and beyond, narios. That is, in approximately 85%
ty. The main result from the paper is that the portfolio is roughly 90% to 95% to 90% of the scenarios evaluated, the
buying retirement annuities in advance invested in equities. For the nearer tar- gradual purchase of annuities over
is generally superior to sticking with a get dates, equity exposure is reduced time results in better outcomes from a
standard TDF until retirement and then and bond exposure is increased, with wealth maximization perspective com-
buying an immediate annuity. the goal of helping investors who are pared with waiting for age 65 to buy a
near retirement to protect their accu- single annuity.
SETTING UP THE ANALYSIS mulated assets. Shoven and Walton further suggest
According to the oft-cited Fact Book With these facts in mind, Shoven’s that the model shows the superiority of
published by the Investment Company and Walton’s analysis asks whether it buying during one’s career, rather than
Institute, TDFs have been a huge market would be superior to add deferred life waiting until retirement, also applies to
success in defined contribution retire- annuities instead of bond funds begin- the purchase of annuities with payouts
ment plans. The ICI data shows their ning at age 50. Their model directs all starting at 75. In fact, the advantage of
share of 401(k) assets has grown from of a theoretical 401(k) plan participant’s the gradual annuity purchase approach Adobe Stock
a mere 8% in 2007 to 31% in 2019, contributions to equities at the start of is actually larger in the case of annuities

12 INVESTMENT ADVISOR FEBRUARY/MARCH 2023 | ThinkAdvisor.com