The Benefit of Diversified Guaranteed Income for Retirees: Combining Immediate Fixed and Immediate Variable Annuities

Abstract

This paper explores the potential benefits of developing a retirement income that considers both immediate fixed annuities (IFA) and immediate variable annuities (IVA) using a stochastic utility model combined with a scenario framework. Optimal annuity allocations vary considerably across household type, but certainty equivalent retirement income increases by 20 percent, on average, when incorporating annuities. Total annuity allocations increase when both IFAs and IVAs are considered, and retirees realize only approximately two-thirds of the benefits of annuitization when just one annuity type is considered. IVA allocations were typically higher than IFA allocations because most households already have a base level of fixed guaranteed income (through Social Security); therefore, IVAs can be a unique diversifier from a retirement-income perspective. Overall, this analysis strongly suggests retirees (and financial advisors) should consider annuities as part of a retirement-income strategy, and that they should consider different types of annuities to create the best possible plan.

Keywords: Immediate Fixed Annuities, Immediate Variable Annuities, Retirement Income, Stochastic Utility Model

JEL Classification: G0, G11