RFI User Guide - Comparing Scenarios to Find The Best Annuity Deferment Period


RFI  - Comparing Scenarios to Find The Best Annuity Deferment Period


As described in RFI Fundamentals, a core idea behind RFI is that a retiree’s monthly spendable funds can be maximized by allocating financial assets between (a) the purchase of a deferred annuity and (b) a portfolio that can be drawn down during the annuity deferment period. One of the key questions that can be answered by RFI is: what is the optimal annuity deferment period based on the retiree's risk tolerance.

In the Scenario input table below we defined 4 scenarios, all with a constant 1% annual increase withdrawal pattern, but each with a different annuity deferment period: 5, 10, 15, and 20 years.  The "Assumed Rate of Return" and the "Rate that Materializes" is the 30th percentile rate for each holding period.  (Note that this example uses a retiree of age 63 with $1 million in financial assets invested in a 50/50 portfolio of stocks/bonds.)


After calculating all 4 scenarios we get the spendable funds chart shown below:

As you can see, Scenarios 3 and 4 (the 15 and 20 year deferment periods) have the highest monthly spendable funds for this set of assumptions. It is also apparent that some of the lines are very close together making it difficult see differences between them.  RFI makes it easy to remove extraneous lines so you can compare fewer scenarios side-by-side. By clicking "Show on Chart" you can add or remove specific scenarios from the chart, as shown below:


In the Scenario input table above we've chosen to display only Scenarios 3 and 4, resulting in the following chart:

In this situation, Scenarios 3 and 4 are still so similar that they essentially overlap each other. Recall from RFI Fundamentals that you can click the "Click here to use this interactive chart ..." button in the upper right of the chart and then move your cursor over any line on the chart to get details on projected results for that age in the future. Note that the "blue box" includes a notation that "Scenario 3 has a similar MSF at this age".  RFI will always display a message of this type when two or more scenarios have similar spendable funds at that point in the future.

It is important to note that in the 4 scenarios defined above, the "Rate that Materializes" was set to the "Assumed Rate" in each case; the rate used was the historical 30th percentile return for the associated holding period.  However, there is clearly more risk in longer holding periods / deferment terms as the retiree is depending in their draw from financial assets during that period (as opposed to "guaranteed" monthly payments once annuity payments begin).

To quantify this risk we will change the "Rate that Materializes" in Scenarios 3 and 4 to the 5th percentile historical returns of 3.6% and 4.2%, respectively. This results in projected spendable funds as shown on the following chart:

As the chart illustrates, a 5th percentile "bad case" assumption results in a significantly worse outcome at ages 78-83 for the 20 year deferred annuity (Scenario 4) with only a marginally worse outcome at ages 63-78 for the 15 year deferred annuity (Scenario 3).

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