However, the EBRI analysis also shows that a key factor in planning for a high level of retirement income adequacy (90%) is whether the costs of long-term care are included in the calculations or not. If they are, no more than 80% − 90% of a retiree’s assets should be converted to an immediate annuity, with the balance reserved to cover long-term care costs. If a longevity annuity is used, retirement wealth should be split between the annuity and equity (stock) investments to ensure long-term care costs are covered.
The technical EBRI report is published in the May 2011 EBRI Issue Brief, online at http://www.ebri.org, and updates earlier computer simulation analysis by EBRI on retirement income adequacy. It focuses on a male retiring at age 65, with specific assumptions on the long-term capital market and investment expenses, the long-term inflation rate, and the mortality table.
Specifically, the report analyzes how differently immediate and longevity annuities can affect probable income adequacy in retirement by taking into account long-term health care expenditures. It attempts to find the optimal level of annuitization and asset allocation that would provide a desired level of confidence that individuals will have sufficient retirement income, based on three different types of risk:
- Investment income (how much money retirement wealth is likely to generate in retirement);
- Longevity (how long the retiree expects to live in retirement); and
- Long-term care (how much is needed to cover nursing home or home health care in retirement).
As EBRI notes, various studies on longevity annuities have found that a modest allocation of retirement wealth to a longevity annuity can deliver as large a benefit as a significant allocation to an immediate annuity. EBRI’s new report compares the impact of immediate and longevity annuities on retirement income adequacy, assuming that a retiree would face long-term health care risk as well as investment income and longevity risk.