# Do Annuities Reduce Bequest Values?

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2 benefit of pooled longevity. In effect, the SPIA purchase converts a 65/35 stock/bond portfolio to an 18/82 portfolio, if the \$284,000 that is left over is invested 65/35. The reduction in bequest values reflects the shift to fixed income. It does not reflect an inadequate return or other deficiency in the SPIA product. Conceptually, the stock allocation could be increased for the remaining \$284,000 above 65/35 in order to bring overall allocations more in line with the original systematic withdrawal strategy. To analyze the impact, we can compare expected bequest values, but we also need to measure how changes in stock allocations affect the volatility of bequests. For this analysis, I measure bequest volatility as the change in the present value of bequests from a 1% reduction in average assumed stock returns. I run Monte Carlo simulations with reduced stock returns, and my risk measure is the difference in the expected present value of bequests before and after the return reduction. Strategies with heavier allocations to stocks will show more bequest volatility. The chart below presents outcomes based on this type of analysis. Comparison of strategies Strategy Probability of failure Bequest Expected PVVolatility Bequest Measure Systematic withdrawal 65/35 stock/bond 9% \$524,000 \$92,000 Purchase SPIA, 63/35 on remainder 0% \$284,000 \$32,000 Purchase SPIA, 100% stocks on remainder 0% \$415,000 \$80,000 Based on this volatility measure, the purchase of the SPIA without changing the allocation of remaining assets reduces risk by almost two-thirds. Even going to 100% stocks with remaining assets is not sufficient to bring the expected bequest back to the systematic withdrawal level, but there is room remaining to increase volatility. One way would be to invest in a higher beta stock portfolio. I tested a portfolio with a beta of 1.25, which raises the real return to 5.85% and volatility to 25.40%. It brings the expected bequest present value up to \$512,000, but it overshoots on the volatility measure, raising it to \$102,000. So we are not able to get all the way to the original bequest with the same or lower volatility, but we are able to move substantially in that direction. Alternate strategies I also tested strategies using SPIAs somewhat differently and using other annuity products. I'll briefly describe various strategies and provide a chart comparing outcomes. Page 2, 2015 Advisor Perspectives, Inc. All rights reserved.

5 to stocks no longer works it overshoots on volatility. I found that allocating 75% to 80% of the remaining funds to stocks keeps volatility within reasonable bounds. I show examples based on a lowcost product and a high-cost product. The low-cost product does very well on the bequest versus volatility tradeoff perhaps the best of all the strategies although this result is uncertain because of all the assumptions and approximations. The higher cost VA/GLWB shows the give-up in bequest value resulting from the higher charges. Except for the higher cost VA/GLWB, all annuity products used in the examples are low-cost versions, which explains the rough similarity of results for the various strategies. One might be tempted to finetune these strategies to determine which is optimal, but the outcomes are results of the particular structure of this example and of the underlying investment assumptions, so I do not believe such finetuning is warranted. When evaluating annuity products, take a holistic view of combinations of products and investment strategies and avoid a narrow focus on only part of the picture. Conclusion It is feasible to use a portion of one s retirement assets to purchase annuities, while aggressively allocating remaining assets in ways that dramatically reduce the risk of depleting savings without sacrificing bequest values. This approach gives advisors more flexibility in choosing which annuity products to recommend. Rather than favoring a particular product, I recommend choosing a low-cost annuity product and making portfolio adjustments to meet objectives. Client characteristics are always important in determining which strategy works best. Joe Tomlinson, an actuary and financial planner, is managing director of Tomlinson Financial Planning, LLC in Greenville, Maine. His practice focuses on retirement planning. He also does research and writing on financial planning and investment topics. Page 5, 2015 Advisor Perspectives, Inc. All rights reserved.

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