A Benchmark for Lifetime Income

The world is filled with investing indexes and benchmarks, and all professional investment managers measure their results relative to some type of performance standard such as the S&P 500.

On the retirement income front, though, similar gauges of performance are virtually non-existent.  The lack of a baseline performance measure is a problem for the industry because there is no established basis for comparison of asset decumulation strategies.

In the most recent Financial Analysts Journal, three authors propose a benchmark for asset decumulation.  In “Making Retirement Last a Lifetime,” Stephen Sexauer, Michael Peskin and Daniel Cassidy propose a model decumulation portfolio that can be used directly by retirees or for the comparison of alternative strategies.

The proposed retirement income portfolio consists of Treasury Inflation-Protected Securities (TIPS) and longevity insurance or a longevity annuity.  The article is timely in light of recent Treasury Department guidance on the use of longevity annuities.

The TIPS are structured in a laddered portfolio that covers the first 20 years of retirement.  At the end of 20 years, a nominal deferred life annuity (a longevity annuity that does not adjust for inflation) kicks-in at an amount that is equal to the last payment from the laddered TIPS portfolio.

The allocation between TIPS and the deferred annuity is determined by expected rates of inflation over the 20 year horizon and the current cost of longevity insurance that starts in year 21 at a level equal to that last TIPS payment.

An example allocation for a 65 year old male as of September 30 2010 is 88 percent TIPS and 12 percent longevity insurance.

The authors acknowledge that a similar benchmark could be created by simply looking at payouts from immediate life annuities.  The problem—as the authors indicate—is that there are so few real life examples of people who annuitize all or most of their wealth, and this hurdle is largely a result of the illiquidity and counterparty risk associated with annuitization.

The proposed benchmark has the benefit of liquidity and relatively little counterparty risk given the 88/12 allocation and the fact that the portfolio owner retains control over almost 90 percent of their assets.

Performance standards such as the retirement income benchmark proposed in the FAJ article are exactly what the emerging retirement income industry needs.

The retirement income industry suffers from a myriad of complex products and solutions that are confusing to both financial advisors and consumers.

Retirement income and investing are fundamentally different, and an asset decumulation strategy cannot use the S&P 500 as a basis for comparison. 

The 10,000 people retiring each day for the next 19 years need something to refer to when their natural reaction to a retirement income pitch is “this sounds interesting, but what can I compare it to in order to make a reasonable decision.”

Source: Financial Analysts Journal