Handling a Fixed Annuity
This chapter addresses the issue of how to handle withdrawals from a portfolio when a portion of your required income stream is supplied by a fixed annuity. I did not see a way to analyze this with just the data available from the Jarrett and Trinity studies, so I tried to find the portfolio size required to cover the impact of inflation (over the specified 30 year period). In the first year the entire annuity would be spent and no withdrawal would be made from the portfolio. In the second year the annuity would be spent and the required increase due to inflation would be taken from the portfolio. This was repeated each year and a portfolio was considered successful if the portfolio lasted through the 30th year. I also used the same range of asset allocations, the same rebalancing assumptions, etc. as stated previously. The size of the initial portfolio was varied between 4x annuity amount and 10x the annuity amount in increments of 1x.
The results of this analysis are presented in three tables:
The results were quite interesting and are different from the results of the Fixed withdrawal methodology referenced in the previous studies in these two ways (among others):
A suggested methodology for handling the case where part of your income requirements are supplied by a fixed annuity is (for calculation purposes) to separate your assets into two baskets:
The hypothetical case of a fixed annuity of $25,000 and a requirement for an inflation adjusted retirement income target of $50,000, would require the following asset base assuming the factors of 9 (inflation protection of the fixed annuity) and .044 are chosen:
$25,000 x 9 + (50,000-25,000)/.044 = $793,000 (gulp)
There is nothing necessarily 'mathematically correct' about the handling this problem as 'two baskets of money'. But it seems to me to be a reasonable approach and should be a good upper bound. For those of you who are mathematically oriented, this assumption is closer to correct when the conditions that negatively affect the Fixed Annuity case and negatively affect the Fixed Withdrawal case are well correlated. This tends to be the true (and unfortunately also generates the highest required portfolio values).
Readers with retirement horizons longer than 30 years, will need to make minor adjustments (something that is partially addressed in the Withdrawals Forever chapter).