Deferred annuities are better deals than immediate annuities

Not only does the early bird get the worm, he gets a higher annuity payout as well.

That’s the finding of a new study that the National Bureau of Economic Research began circulating earlier this month. Entitled “Target Retirement Fund: A Variant on Target Date Funds That Uses Deferred Life Annuities Rather than Bonds to Reduce Risk in Retirement,” the study was conducted by John Shoven, an economics professor at Stanford University, and Daniel Walton, a data scientist at Uber Technologies.

The researchers constructed a hypothetical Target Retirement Portfolio (TRF) that, like a traditional target date fund (TDF), gradually reduces its equity exposure beginning at the age of 50. But instead of investing the proceeds of these equity sales in bonds, the researchers invested them instead in deferred annuities that begin their monthly guaranteed payments at age 65. They then calculated how much it would cost for the traditional TDF, at age 65, to purchase a single annuity that produces the equivalent monthly payout as the TRF’s annuity ladder.

At this point the two portfolios produce the same monthly annuity payout, and their only difference will be how much the rest of their portfolios are worth. The researchers ran hundreds of simulations based on historical returns on stocks, bonds, and Treasury interest rates, and found that in nearly 90% of the cases their hypothetical TRF portfolio had significantly more non-annuity assets than the TDF.

In other words, you get a lot more annuity bang for your buck if you buy annuities in stages over the years prior to when you would otherwise purchase a single annuity.

Is there a catch with the annuity ladder approach? Perhaps, Shoven said in an interview, though you may not consider it a deal breaker: If you die between ages 50 and 65, you will receive nothing in return for what you invested in the annuities. Fortunately, the odds of a 50-year-old dying before reaching 65 are very low.

You may also object to the annuity ladder approach on the grounds that it reduces what otherwise might be available to your heirs. But Shoven pointed out that their simulations focus on a retiree who otherwise purchases an annuity at age 65. The issue their research addresses is not whether to invest in an annuity, but instead whether to do so in one fell swoop at age 65 or in stages beginning at age 50.

What was the source of the superior returns of the researchers’ TRF portfolio? They identify two:

  • Lower sequence risk: This risk refers to the traditional TDF’s vulnerability to the path interest rates take after age 50 (which impacts bonds’ returns), as well as the level of interest rates at age 65 (which impacts how much you must pay to secure a given annuity payout). The TRF is less vulnerable to sequence risk because its annuity payout in retirement is a function of interest and annuity prices at different points throughout the 15 years from age 50 to age 65.

  • Less “adverse selection”: Adverse selection refers to the tendency for those purchasing annuities to be the healthiest individuals with the longest life expectancies. As a result, annuity providers must charge a 65-year-old a higher price for an immediate annuity than they would have if that same person had, beginning at age 50, bought deferred annuities that didn’t begin monthly payouts until age 65.

The bottom line? If you were already considering the purchase of an annuity when you retire, consider purchasing instead a series of annuities in stages beginning at age 50. By doing that you very likely will increase the amount you will have to live on during retirement.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at

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