Converting Retirement Savings into Income: Annunities and Periodic Withdrawals

^Pr^ep^ar^{ed f}^o^r^M^e^m^b^ers^an^d^Com^mⁱ^t^t^ees^of^C^ong^r^e^ss

To a worker contemplating retirement, there is perhaps no more important question than “How
long will my money last?” Congress has a strong interest in the income security of older
Americans because much of their income is either provided directly from public programs like
Social Security, or in the case of pensions and retirement accounts, is subsidized through tax
deductions and deferrals.
Many retirees must decide how to convert retirement account balances into income and how to
preserve the accounts in the face of several kinds of risk.
• Longevity risk is the risk that the individual will exhaust his or her account before
death and experience a substantial decline in income.
• Investment risk is the risk that the assets in which the individual has invested his
or her retirement account will decline in value.
• Inflation risk is the risk that price increases will cause the individual’s retirement
income to decline in purchasing power.
• Unexpected events such as divorce, the death of a spouse, the cost of medical
care, or a need for long-term care services are also risks.
There are strategies for dealing with each of these risks, but no single strategy can deal effectively
with all of them. For example, purchasing a life annuity insures against longevity risk and it shifts
the investment risk to the insurer. However, purchasing an annuity depletes the purchaser’s
available assets by the amount of the premium. These assets are no longer available to the retiree
in the event of a catastrophic illness or other unexpected major expense. To date, the demand for
annuities has been low. There are many reasons for the low demand for annuities, but one of the
most important has been that many potential annuity purchasers do not value the longevity
insurance provided by annuities at its market price.
Retirees who choose not to purchase life annuities must decide how much to withdraw from their
retirement accounts each year. Because they face uncertainty with respect to both life expectancy
and the rate of return on investment, this decision carries its own risks. If withdrawals are too
large, retirees risk spending down their savings too quickly, possibly leaving them impoverished.
If withdrawals are too small, they might spend too little and leave substantial assets unspent when
they die.
An analysis conducted by CRS indicates that under specific conditions there is a 95% or greater
probability that a man who retires at age 65 will not exhaust his retirement account before the
earlier of death or age 95 if his initial withdrawal does not exceed 5% of the account balance and
later withdrawals are the same in inflation-adjusted dollars. Under the same conditions, there is a
95% or greater probability that a woman who retires at age 65 will not exhaust her retirement
account before the earlier of death or age 95 if her initial withdrawal does not exceed 4.5% of the
account balance and later withdrawals are the same in inflation-adjusted dollars.

Introduc tion ..................................................................................................................................... 1
The Nature of Risk in Retirement...................................................................................................2
Longevity Risk..........................................................................................................................2
Inflation Risk.............................................................................................................................3
Investment Risk.........................................................................................................................4
Unexpected Events....................................................................................................................4
Annuities as a Source of Retirement Income..................................................................................5
The Current Market for Annuities.............................................................................................6
Group Annuities..................................................................................................................6
Individual Annuities............................................................................................................7
Tax Treatment of Annuities.....................................................................................................10
Taxation of Income from a Fixed Annuity........................................................................10
Taxation of Income from a Variable Annuity.....................................................................11
Tax Exclusion for Long-Term Care Insurance...................................................................11
Consumer Protections and the Regulatory Environment........................................................12
State Regulation of Annuities...........................................................................................12
Federal Regulation of Annuities.......................................................................................13
Why Is Demand for Individual Annuities So Low?................................................................13
Complexity and Lack of Transparency in Annuity Expenses...........................................14
Lack of Flexibility in Dealing with Unexpected Expenses...............................................15
Retirement Account Withdrawal Strategies...................................................................................16
How Long Will a Retirement Account Last with Fixed Annual Withdrawals?.............................16
Initial Rate of Withdrawal.......................................................................................................17
Investment Portfolio................................................................................................................18
Probability of Assets Lasting for at Least a Specific Number of Years............................18
Portfolio of 65% Stocks and 35% Bonds..........................................................................18
Portfolio of 35% Stocks and 65% Bonds..........................................................................19
Estimates Incorporating Life Expectancy...............................................................................20
Estimates of Variable Annual Withdrawals.............................................................................24
Summary of Withdrawal Strategies: Balancing Risks...................................................................29
Figure 1. Growth in Annuity Sales Relative to Growth in the S&P 500 Index...............................9
Table 1. Estimated Percentage of Individuals Age 65 in 2004 Surviving to Selected Ages...........3
Table 2. Annual Average Rate of Return Over 10- Year Period......................................................4
Table 3. Monthly Income By Gender and Joint/Survivor Option for Fixed Annuity With
a $100,000 Premium, 2008..........................................................................................................8
Table 4. Tax Treatment of Annuities...............................................................................................11

Table 5. Estimated Probability a Retirement Account Will Last for at Least a Specific
Number of Years.........................................................................................................................19
Table 6. Probability of Retirement Account Lasting to at Least a Given Age, Including
Mortality Risk, Retirement at Age 60........................................................................................22
Table 7. Probability of Retirement Account Lasting to at Least a Given Age, Including
Mortality Risk, Retirement at Age 65........................................................................................23
Table 8. Probability of Retirement Account Lasting to at Least a Given Age, Including
Mortality Risk, Retirement at Age 70........................................................................................24
Table 9. Variable Annual Withdrawals Based on Life Expectancy, Retirement at Age 60...........27
Table 10. Variable Annual Withdrawals Based on Life Expectancy, Retirement at Age 65.........28
Table 11. Variable Annual Withdrawals Based on Life Expectancy, Retirement at Age 70.........29
Table B-1. Life Expectancy at Each Age, in Years........................................................................32
Appendix A. What is “Monte Carlo” Analysis?............................................................................31
Appendix B. United States Life Tables, 2004...............................................................................32
Author Contact Information..........................................................................................................33

The 78 million members of the “baby boom” generation are beginning to retire.¹ After many
years of accumulating assets to spend in retirement, they now must decide how to convert these
assets into a steady stream of income. Because of the trend away from defined benefit (DB)
pensions to defined contribution (DC) plans—such as 401(k) plans—future retirees will be less
likely to have a guaranteed stream of income from defined benefit pensions. Furthermore, while
Social Security will provide a guaranteed income to most retirees, it will replace only a relatively ²
small proportion of their pre-retirement income. As a result of these trends, many future retirees
will rely greatly on their savings to finance their consumption during retirement.
A retiree who is deciding how to convert wealth into retirement income will have to balance
many risks. Increases in average life expectancy will mean that future retirees will have to ensure
that their wealth will last through a retirement that could span 30 or 40 years. Increased volatility
in equity markets, the effects of inflation on purchasing power, and the possibility of substantial
expenses for medical treatment and long-term care will further complicate this decision.
There are a number of ways to convert retirement wealth into income. One option is to purchase a
life annuity from an insurance company. In exchange for payment of an initial premium, a life
annuity pays a guaranteed income throughout retirement, regardless of how long the purchaser ³
lives. Life annuities represent only about 5% of individual annuities sold in the United States.
Most annuities sold in the U.S. are deferred annuities, which are tax-deferred retirement savings
accounts. At retirement, a deferred annuity can be converted to a life annuity; yet, relatively few
deferred annuities are converted to life annuities. Likewise, most individuals who have
accumulated retirement savings in 401(k) plans or individual retirement accounts (IRAs) choose
to access these funds through lump-sum distributions or periodic withdrawals rather than by
purchasing a life annuity.
There are many reasons why relatively few retirees choose to purchase a life annuity as a source ⁴
of retirement income. Among these reasons are that
• most retirees receive annuity income from Social Security;
• about one-third of retirees receive annuity income from defined benefit pensions;
• the fees charged by annuity providers can be high and the fee structure is not
transparent;
• purchasing an annuity reduces the assets available to the retiree to meet
unexpected expenses, and breaking the contract is costly; and
¹
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^low^-^w^a^ge^w^o^r^k^e^r^{, 41%}^of^e^a^rⁿⁱⁿ^g^s^f^o^r^a^c^a^r^e^e^r^-^l^ong^m^e^diaⁿ^-^w^ag^{e w}^o^r^k^e^r^{, a}^{nd 27%}^of^e^a^r^ning^s^f^o^r^a^c^a^r^e^e^r^-^l^ong^hig^h^-
^wa^g^e^wo^r^k^e^r^.
³^Lⁱ^fe^a^nnuitie^s^a^r^e^a^l^s^o^s^o^m^e^tim^es^c^a^lle^{d im}^m^e^dia^t^e^a^nnuitie^s^.^T^h^is^re^port^us^e^s^the^s^e^te^rm^s^inte^rc^ha^nge^a^b^ly^.
⁴^S^o^m^eⁱⁿ^dⁱ^vi^du^al^{s ch}^oo^{se no}^t^t^o^s^p^en^d^asset^s^b^ecau^{se t}^h^ey^wⁱ^sh^t^o^l^{eave t}^h^{e asset}^s^{as a b}^e^q^u^e^st^t^o^t^h^eⁱ^{r h}^eⁱ^r^s.
^H^o^w^e^v^e^r^,^gⁱ^ve^{n tha}^t^aⁿⁱⁿ^divⁱ^dua^l^c^hoos^e^s^t^o^s^p^eⁿ^{d s}^o^m^e^or^a^{ll of}^his^or^he^r^r^e^tⁱ^r^e^m^e^{nt s}^a^vⁱ^ng^s^,^the^r^e^le^v^a^{nt que}^s^tioⁿ
^f^o^r^this^aⁿ^a^l^y^s^is^is^w^h^y^r^e^la^tiv^e^l^y^f^e^w^c^hoos^e^{to d}^o^s^o^by^pur^c^h^a^sⁱⁿ^g^a^lif^e^a^nnuity^.

• there have been instances of deceptive sales practices by some agents, many of
whom receive large commissions for each sale.
Another option for converting retirement savings into income is to take periodic withdrawals
from a retirement account. Some retirees attempt to “self-annuitize” by basing the amount of each
periodic withdrawal from the account on their remaining life expectancies. Retirees who self-
annuitize take on the responsibility of managing their investments and also the risk that they will
live longer than average.
This report has two sections. The first section describes four kinds of risk that retirees face in
retirement: longevity risk, investment risk, inflation risk, and the risk of large, unexpected
expenses for medical care or long-term care. It then describes the basic features of life annuities
and examines some of the reasons that the market for these annuities remains small, in spite of the
protection that they provide against outliving one’s retirement assets. The second section of the
report describes various strategies for self-annuitizing and presents the results of an analysis that
CRS conducted to estimate the probability that an individual who elects to self-annuitize would
exhaust his or her retirement assets before death.

Decisions about how to draw down assets in retirement must take into account many risks. These
include longevity risk (i.e., the risk that one will live beyond the average life expectancy),
inflation risk, investment risk, and the risk associated with unexpected financial shocks from
widowhood, divorce, medical care, or the need for long-term care services.
The U.S. population is living longer than previous generations. A man who reached age 65 in
1960 could expect to live another 13.0 years, while a woman who turned 65 in 1960 had a
remaining life expectancy of 15.8 years. A man who reached age 65 in 2004 could expect to live
another 17.1 years, while a woman who turned 65 in 2004 had a remaining life expectancy of ⁵
20.0 years. Looking beyond the averages, more than one-fourth of women who reach age 65 are
likely to live to age 90, and 12.4% are likely to live to age 95. One out of six men who attain age
65 will live to age 90, and an estimated 6% will live to age 95. (See Table 1). Individuals who
underestimate the likelihood of living into very old age might spend their assets too quickly,
depleting their savings while they still have many years to live. This could lead to a decline in
their standard of living, and possibly to increased reliance on public assistance programs.
⁵
^{U.S. Na}^tio^na^{l Ce}^nte^r^f^o^{r He}^a^lth^Sta^tistic^{s, Na}^tiona^l^Vita^{l Sta}^tistic^{s Re}^port,^Uⁿ^ite^d^St^ate^s^Life^T^a^b^l^e^s^{, 20}⁰⁴^{, V}^o^l^.
⁵⁶⁽⁹⁾^{, (}^D^e^c^.²⁰⁰⁷⁾^.

Table 1. Estimated Percentage of Individuals Age 65 in 2004
Surviving to Selected Ages
^{Surviving to Age}^Total^Male^Female
^{75 66.6}^60.3^72.7
^{80 53.9}^46.5^61.0
^{85 38.3}^30.6^45.4
^{90 22.2}^15.9^27.8
^{95 9.4}^5.8^12.4
^{100 2.5}^1.3^3.5
^Source:^{U.S. National Center for Health Statistics, National Vital}^Statistics
^Report,^{United States Life Tables, 2004}^{, vol}^{. 56(9), (December}²⁰⁰^7).
As overall prices in the economy rise over time, the purchasing power of income declines unless
income increases at the same rate that prices increase. Few pensions in the private sector provide
regular cost-of-living increases. Data collected by the Department of Labor indicate that fewer
than 5% of pensions in the private sector provide regular cost-of-living adjustments to retirees.
Retirees must account for the potential impact of inflation on their investment portfolios as they
decide how to draw down their retirement wealth.
Social Security is one of the few sources of retirement income that is fully inflation-indexed each
year. Yet, even Social Security’s annual cost-of-living adjustments may not fully protect
retirement income from the effects of inflation. The annual cost-of-living adjustment for Social
Security is based on the increase in the overall level of prices. Prices for some categories of
expenditures that the elderly use at higher rates than younger consumers – such as health care –
have been growing faster than overall prices. Over the period from 1980 to 2007, the average
annual rate of inflation for goods and services averaged 3.5%, but prices for medical care rose at ⁶
an average annual rate of 5.9%. For those who have above-average out-of-pocket health care
expenditures, these price increases can significantly reduce the amount of income available for
other expenditures. In addition, Medicare Part B premium increases are tied to program cost ⁷
increases which have historically exceeded growth in general inflation. By 2025, these premiums
are expected to equal over 50% of the average Social Security benefit, as compared to 27% in ⁸

2006.

⁶
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^f^o^r^m^e^dic^a^l^c^a^r^e^r^o^s^e^f^r^om^{74.9 to}³⁵^1.1^.^Se^e^C^o^unc^il^of^Ec^on^om^ic^A^d^vⁱ^s^e^r^s^,^Ec^onom^ic^Re^por^t^{of t}^h^e^Pr^e^s^ideⁿ^t,
^Fe^br^uar^y²⁰⁰⁸^,^T^a^ble^B^-⁶⁰^,^p.²⁹^5.
⁷^Se^e^C^R^S^R^e^por^{t R}^L³³³⁶⁴^,^T^h^e^I^m^pac^{t o}^f^M^e^dic^a^re^Pre^m^{iums o}ⁿ^Soc^ia^{l Se}^c^u^rity^Be^ne^fic^iarie^s^{, by}^K^a^thle^eⁿ^Romⁱ^g^,.
⁸^{CRS e}^s^tim^a^t^e^s^ba^s^e^{d on da}^ta^re^p^o^rte^dⁱⁿ^CM^{S O}^f^fⁱ^ce^of^the^A^c^tua^r^y^Mem^o^ra^ndum^{, “A}^dditiona^{l I}ⁿ^f^o^rm^a^tion
^R^e^g^a^r^d^ing^C^o^m^p^a^r^is^ons^of^B^e^ne^fⁱ^cⁱ^a^r^y^Iⁿ^c^o^m^e^a^{nd O}^u^t-^of^-^P^oc^k^e^{t C}^o^s^t^s^For^Me^dic^a^r^e^Su^pp^le^m^e^ntar^y^Me^dic^a^l
^In^su^ran^{ce.” March}²⁵^,²⁰⁰⁸^.

Investment risk is the possibility that an individual’s retirement assets might decline in value
because specific stocks, bonds, or other assets depreciate. Diversification can reduce investment
risk, because declines in the value of some assets are likely to be fully or partially offset by gains
in the value of other assets. Stock and bond mutual funds, for example, help protect individuals
from investment risk by purchasing securities from many companies in a variety of industries. In
a mutual fund, investment losses from companies that are performing poorly may be offset by
investment gains from companies that are performing well.
Investment risk includes market risk, which is the possibility that an individual’s retirement assets
will decline in value because of an overall decline in asset prices, as when the stock market falls.
Even a well-diversified portfolio of stocks will not protect the value of an individual’s retirement
from depreciating if stock values fall across the board, as they have in 2008. Although a
diversified portfolio can moderate investment risk, there have been extended periods of time
when declines in the stock market and low interest rates resulted in negative returns on
investment. For example, between 1929 to 2006 there were 14 ten-year periods of negative
annual rates of return after adjusting for inflation. Table 2 shows the five worst of those 14 ten-
year periods. There have also been instances when negative rates of return spanned 15 years.
Between 1966 and 1981, real rates of return on stocks averaged -0.4%, and the average annual ⁹
real rate of return on short-term government securities was -0.2%. Those who retire at the
beginning of a period of negative returns could face significant reductions in retirement wealth.
Table 2. Annual Average Rate of Return Over 10- Year Period
⁽^{adjusted for}^inflation)
^Portfolio^Mix
^{Time Period}^{65% Stocks/3}^{5% Bonds}^{65% Bonds/35% Stocks}
¹⁹⁶^{8 to 1}⁹⁷⁸^-4.3^-1.8
¹⁹⁷^{2 to 1}⁹⁸²^-4.0^-1.7
¹⁹⁶^{4 to 1}⁹⁷⁴^-3.9^-1.3
¹⁹⁷^{1 to 1}⁹⁸¹^-3.8^-1.6
¹⁹³^{8 to 1}⁹⁴⁸^-3.6^-3.4
^Source:^{CRS analysis of data from Ibottson Associates.}
Unexpected events can adversely affect retirement income. These include losing a spouse through
death or divorce, high medical expenses, and the need for long-term care services. According to a
recent study by the Urban Institute, more than two-thirds of adults age 70 and older experienced
at least one such financial shock over a nine-year period. Widowhood occurred among nearly
⁹^nd
^Sⁱ^egel^,^Jere^my^J.^Stoc^k^s^for^the^L^ong^-^R^uⁿ^{. 2}^e^d^{. Ne}^w^York^{: Mc}^Gra^w^-^H^{ill. 19}⁹⁸^.

one-third of married adults over age 70. The study found that widowhood was more likely to ¹⁰
reduce women’s wealth than men’s wealth.
Unexpected health care costs can also reduce retirement wealth. Although the majority of retirees
are covered by Medicare, deductibles and co-payments can be significant for those who are
seriously ill. Medicare provides only limited coverage for long-term hospital stays and nursing
home care. A recent analysis of the Health and Retirement Survey found that 6% of households ¹¹
aged 75-84 paid more than 50% of their income for out-of-pocket medical expenses. These
costs can be especially high at the end of life when a surviving spouse may face large medical
bills and an accompanying reduction in retirement income. A study in 2002 found that out-of-
pocket costs for end-of-life medical expenses could average about $23,000 (adjusted to 2007 ¹²
dollars). While the introduction of Medicare Part D may offset some of these costs, even under
this program an individual who is not eligible for a low-income subsidy could be responsible for
more than $6,000 in copayments for prescription medicines in 2009.
Another potential economic shock is the cost of long-term care services.¹³ It has been estimated
that over two-thirds of individuals aged 65 and older will require long-term care services at some
point in their lives. In 2008, the annual average cost of a nursing home stay is $68,255 for a semi-¹⁴
private room and $76,285 for a private room. These costs greatly exceed the 2007 median
income of $29,730 among households in which either the householder or householder’s spouse ¹⁵
was 65 or older. Medicare does not cover extended stays in nursing homes, and Medicaid
coverage generally is available only to individuals who are poor or become poor by spending ¹⁶
down their assets on long-term care services. For those who are not Medicaid-eligible and who
have not purchased private long-term care insurance, long-term care costs must be paid out-of-
pocket.

A life annuity – also called an immediate annuity – is an insurance contract that provides income
payments on specified dates in return for an initial premium. Life annuities can help protect
retirees against some of the financial risks of retirement, especially longevity risk and investment
risk. Life annuities pay income to the purchaser for as long as he or she lives, and in the case of
joint-and survivor annuities, for as long as the surviving spouse lives. In addition, some annuities
¹⁰
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^a^{nd J}^o^{b L}^a^y^o^f^f^s^a^t^O^l^de^r^A^g^es^,”^U^r^{ban I}ⁿ^s^tit^ute^{, 20}^06.
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⁽^S^um^m^e^r²⁰⁰⁷⁾^,^p.⁵⁹^-⁸^0.
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¹⁶⁴^{2, 20}⁰²^.
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^{no l}^ong^e^r^c^a^r^e^f^o^{r the}^m^se^l^v^e^s^due^to^phy^sic^a^l^{or c}^o^gⁿ^itiv^e^im^pa^ir^m^e^nts.
¹⁴^G^eⁿ^w^or^{th Fina}^nc^ia^{l 2}⁰⁰⁸^C^o^s^t^of^C^a^r^e^Sur^v^ey^{, A}^p^r^{il 200}^8.
¹⁵^T^h^is^m^e^diaⁿ^inc^o^m^e^is^ba^s^e^{d on t}^h^e^99%^of^hous^e^h^ol^ds^w^{ith a}ⁿ^y^inc^o^m^e^{. Se}^e^C^R^S^R^e^por^{t R}^L³²⁶^97,^Iⁿ^co^{me an}^d
^Pov^e^r^ty^Am^on^{g O}^l^de^r^Am^e^r^ic^ans^{in 2}⁰⁰⁷^{, by}^P^a^tric^k^P^u^rc^e^ll.
¹⁶^T^h^e^Me^dic^aⁱ^{d s}^t^a^t^ute^pr^o^hⁱ^b^itsⁱⁿ^divⁱ^dua^ls^f^r^om^tr^aⁿ^s^f^e^r^rⁱ^ng^theⁱ^r^a^s^s^e^ts^{to ot}^he^r^sⁱⁿ^or^de^r^t^o^qua^lif^y^f^o^r^Me^dic^aⁱ^d.
^T^h^e^law^a^l^s^o^pr^ote^c^t^s^s^o^m^e^of^the^inc^o^m^e^a^{nd a}^s^s^e^ts^of^the^c^o^m^m^uⁿ^ity^s^pous^e^of^a^nur^sⁱ^ng^h^o^m^e^r^e^side^{nt s}^o^tha^t^he^or
^s^h^e^is^no^{t im}^pov^e^r^is^he^d.

offer limited protection against inflation through annual increases. However, the annual increases
must be paid for by accepting a lower initial monthly annuity income. Other annuities allow the
purchaser to share in the investment gains from growth in equity markets as a way to offset the
effects of inflation; however, such annuities also require the purchaser to share in the investment
losses if markets fall.
Despite the potential advantages of annuities in reducing longevity risk and investment risk, life
annuities continue to represent a small proportion of all annuities sold in the U.S. In recent years,
deferred annuities – used as tax-deferred savings vehicles – have outsold life annuities by a ratio ¹⁷
of almost 20 to 1. As noted earlier, the irrevocable nature of annuity contracts appears to be an
important factor in dissuading many retirees from purchasing life annuities. Although insurers
have devised options to assure that the payments will continue after the purchaser’s death – joint-
and-survivor annuities, and term-certain annuities, for example – these options add to the cost of
the annuity. Because of the projected increase in the number of older Americans over the next 20
years, and the concurrent increase in the potential market for life annuities, insurers are likely to
continue to add features to their annuity products in an attempt to broaden their appeal to retirees.
Annuities are either provided through employer-sponsored pension plans (the group market) or
are purchased directly by individuals (the individual market).
Annuities from defined-benefit pensions can protect retirees from investment risk and longevity
risk. The benefit formula under most defined benefit pensions is based on the worker’s years of
service and final average salary. The individual’s benefit does not vary with investment returns, ¹⁸
nor does it decrease as a result of increases in average life-expectancy. The employer that
sponsors the plan bears both the investment risk and the longevity risk. If investment returns fall
below expectations, or if the plan’s actuaries project increases in life expectancy, the plan sponsor
must provide additional funding to the plan to meet these costs. Since the mid-1980s, the
proportion of workers who retire with a defined benefit pension has declined substantially. The
number of workers participating in defined benefit pension plans fell from 26.9 million in 1985 to ¹⁹

20.6 million in 2006, a decline of 23%.

Another reason for the decline in the number of workers retiring with an employer-sponsored
annuity has been an increase in the number of defined benefit plans that offer the option of taking
a lump-sum rather than an annuity. Of all those who are covered under a defined benefit plan, ²⁰
more than half are offered the choice between a lump sum and an annuity. When offered this
choice, many individuals choose the lump-sum option. According to a study by the Vanguard
Group, only 40% of defined benefit plan participants who are offered a lump-sum choose to
¹⁷
^Na^tiona^{l A}^ssocⁱ^a^tion^of^V^a^ria^b^le^A^nnuitie^s,²⁰⁰⁷^Fa^c^t^bo^ok^.
¹⁸^A^lthoug^{h a}ⁿ^nui^ty^pay^outs^v^a^r^y^de^pe^ndi^ng^on^the^a^g^e^of^r^e^tir^e^m^eⁿ^{t, the}^s^e^pa^y^outs^a^r^e^not^tie^d^{to a}ⁿⁱ^ndivⁱ^d^u^a^l^’^s^owⁿ
^lif^e^e^x^pec^t^aⁿ^cy^{but r}^a^the^r^t^h^a^t^of^a^g^r^oup^of^indivⁱ^d^u^a^l^s^.
¹⁹^P^e^ns^io^{n B}^e^ne^f^{it G}^u^a^r^aⁿ^t^y^C^o^r^p^o^r^a^tion,^Pe^ns^io^{n I}ⁿ^s^u^r^a^nc^e^D^a^ta^B^ook^,²⁰⁰⁶^.
²⁰^Bure^a^u^of^L^a^{bor Sta}^tistic^s,²⁰⁰⁷^N^a^tio^nal^C^o^m^p^eⁿ^s^a^ti^on^S^u^r^v^e^y^.

receive an annuity.²¹ Given these trends, the share of retirement income that will be guaranteed in
the form of a defined benefit annuity is likely to decline in the future.
Annuities purchased directly from insurance companies or from insurance agents or brokers by
individuals are called individual annuities. Two features that vary across individual annuities are
the timing of payments and the rates of return.
Annuities can either be deferred, in that premiums are paid and assets are accumulated while the
individual is working and payment of income is deferred until the worker retires, or immediate, in
which a single premium is paid in exchange for lifelong stream of income that begins
immediately.
A deferred annuity is similar to a savings account in which individuals can accumulate money
over time. Investment earnings accrue on a tax-deferred basis. Deferred annuities represent nearly
95 percent of annuity sales. While individuals holding a deferred annuity can convert the funds
into a guaranteed stream of income in retirement, most take a lump-sum payment or a series of ²²
periodic withdrawals.
An immediate annuity provides a guaranteed monthly income for a specified period of time in
exchange for a one-time premium payment. Income from an annuity can be either fixed or
variable. Income from an annuity may be a received for specific number of years, as with a term
certain annuity, for the life of the annuitant, as in a single-life annuity, or for the lives of both the
annuitant and his or her spouse, as in a joint and survivor annuity. Under a joint and survivor
annuity, the surviving spouse is eligible to receive income until he or she dies. The survivor
benefit is typically 50%, 75%, or 100% of the income received while the annuity purchaser was
living. As noted earlier, while immediate annuities can protect retirees from longevity risk and
transfer the investment risk to the insurer, only 5% of individual annuities currently sold are ²³
immediate annuities.
Table 3 shows some examples of monthly income from an immediate annuity. Most annuities
purchased in the private sector provide different incomes for men and women. Men can purchase
an annuity with a higher monthly income than women for the same premium because the average
life expectancy of a man is lower than for a woman of the same age. The average lifetime values
of the annuities for a man and woman of the same age would be equal. Employer-sponsored ²⁴
pension plans must offer unisex annuities to retirees. Under a unisex annuity, a man would
²¹
^G^.^Mottola^,^aⁿ^d^{S. U}^t^k^u^s^,^“^L^um^p^Sum^or^A^nnuity^?^Aⁿ^Aⁿ^a^l^y^s^is^of^C^hoic^eⁱⁿ^D^B^P^e^nsⁱ^oⁿ^P^a^y^outs^,^”^Va^ng^ua^r^d
^Cen^t^{er f}^o^{r Ret}ⁱ^r^emen^t^Research^,^vo^l^.³⁰^,^No^vem^b^{er 2}⁰⁰⁷^.
²²^Nati^on^{al Assoc}ⁱ^atioⁿ^{of V}^a^ria^b^le^Ann^u^itie^s,²⁰⁰⁷^Fac^t^bo^ok^.
²³^Nati^on^{al Assoc}ⁱ^atioⁿ^{of V}^a^ria^b^le^Ann^u^itie^s,²⁰⁰⁷^Fac^t^bo^ok^.
²⁴^T^h^e^Uⁿ^ite^{d Sta}^t^e^s^S^upr^e^m^e^C^our^{t r}^u^le^dⁱⁿ¹⁹⁸³^tha^t^un^de^r^f^e^de^r^a^{l c}ⁱ^v^{il r}ⁱ^g^h^ts^s^t^a^t^ute^s^{, e}^m^ploy^e^r^-^s^pons^or^e^d
^re^tire^m^eⁿ^{t pla}ⁿ^{s c}^aⁿⁿ^o^t^of^f^e^{r a}^nnuitie^{s tha}^t^dif^f^e^re^ntia^te^{on the}^ba^{sis of}^g^e^nde^{r. Se}^e^Ar^iz^on^{a G}^o^v^e^rⁿⁱ^{ng C}^o^m^m^.^v^.
^No^rris^{, 4}^{63 U}^.^S.¹⁰^{73 (}¹⁹⁸³⁾^.

receive a lower monthly annuity income than he would get from a gender-based annuity,
reflecting the higher average life expectancy of a group that includes both men and women.
Likewise a woman would receive a higher monthly annuity income from a unisex annuity than
she would receive would from a gender-adjusted annuity.
Table 3. Monthly Income By Gender and Joint/Survivor Option
for Fixed Annuity With a $100,000 Premium, 2008
^{Unisex Male}^Female
^{Age 60}^{Single Life}⁶⁹⁰⁷¹⁶⁶⁶⁶
^{Joint and Survivor}⁶⁴⁵⁶⁵⁶⁶⁴⁵
^{Age 65}^{Single Life}⁷¹⁴⁸⁰¹⁷³⁴
^{Joint and Survivor}⁶⁵⁷⁷²¹⁷⁰⁷
^{Age 70}^{Single Life}⁸⁶⁹⁹¹⁷⁸²⁸
^{Joint and Survivor}⁸¹⁰⁸¹¹⁷⁹³
^Source:^{Based on CRS Ann}^uity^{Calculator. Assumes fixed real (in}^{flation-adjusted) rate of}
^retur^{n eq}^{ual to historical average}^{of 2.8%, and}^{no added adjustmen}^{ts for adverse s}^election.
Annuities are similar to other investment vehicles in that purchasers earn a rate of return on their
premium investment. The rate of return on the annuity can be fixed, indexed, variable, or some
combination of the three. The risk, regulation and fee structure varies across these different types
of annuities.
A fixed annuity pays a fixed monthly payment for the term of the annuity. The amount of the
monthly payment is determined at the time the annuity is purchased. The income that any given
premium amount will purchase depends mainly on the age of the purchaser (and the age of the
purchaser’s spouse in the case of a joint and survivor annuity) and prevailing market interest rates
for medium-term bonds at the time the annuity is purchased. In 2007, fixed annuities represented ²⁵

22% of annuity sales.

²⁵
^Nati^on^{al Assoc}ⁱ^atioⁿ^{of V}^a^ria^b^le^Ann^u^itie^s,²⁰⁰⁷^Fac^t^bo^ok^.

Figure 1. Growth in Annuity Sales Relative to Growth in the S&P 500 Index
^{S&P 500}^Index
^80%^Fix^{ed A}^nnuitⁱ^es
^60%^E^quit^y^-I^ndex^{ed A}^nnuitⁱ^es^V^a^{riable A}^nnuitⁱ^e^s
^40%
^20%
^0%
^-^20%
^-^40%
1998 1999 2000 2001 2002 2003 2004 2005 2006
^Source:^{CRS estimates based on}^{data from National Association of Variable Annuity, 2}⁰⁰⁷^An^nuit^{y Factbook.}
^{Data on growth in e}^{quity mar}^ket^{s based on a}ⁿⁿ^{ual rate of ret}^urⁿ^{of S&P index reported}^{by I}^bbotso^{n Associates.}
A variable annuity offers annuity purchasers a choice of a wide range of investment options that
can vary in value over time. The investment options can include stocks, bonds and money market
portfolios. The monthly income provided by a variable annuity will fluctuate according to the
investment performance of the funds in which the annuity premium is invested. Income from a
variable annuity can decline if the investment underlying the annuity loses value. Some variable
annuity policies offer limited protection against declines in value through a guaranteed minimum ²⁶
income. In 2007, the majority of annuity sales (67%) comprised variable annuities.
An equity-index annuity earns a rate of return based on the performance of an equity index fund.
Examples of equity indexes used include Dow Jones Industrial Average, Lehman Brothers
Aggregate U.S. Index, and Standard and Poor’s (S&P) 500 Composite Stock Price Index. If the
underlying index declines, the income provided by the annuity will also decline. To reduce this
risk, the insurer in some cases may provide a guaranteed minimum payment to protect the
consumer against market fluctuations. This minimum, however, costs more to annuity purchasers ²⁷
by reducing their initial annuity income. In 2007, 11% of annuity sales were indexed annuities.
The demand for each type of annuity is influenced by rates of return in equity markets. A strong
equity market reduces demand for fixed annuities while a weak stock market increases demand
for fixed annuities. During the strong equity market in late 1990s, growth in variable annuities
sales exceeded growth in fixed annuity sales. By early 2000, when equity markets were earning
negative rates of return, the demand for variable annuities fell. After 2000, growth in variable
annuity sales dominated the market. (See Figure 1.)
²⁶
^Ibid^.
²⁷^Nati^on^{al Assoc}ⁱ^atioⁿ^{of V}^a^ria^b^le^Ann^u^itie^s,²⁰⁰⁷^Fac^t^bo^ok^.

Inflation-indexed annuities preserve the purchasing power of annuity income by providing a
lifetime stream of income that increases with inflation. Treasury Inflation Protected Securities
(TIPS) could be used as an investment vehicle by insurers that would like to offer inflation-
indexed annuities, but few U.S. insurers offer such annuities. Potential purchasers have proven
unwilling to accept a substantially lower initial payment in exchange for protection against
inflation. Some insurers offer graded annuities that provide annual increases in payments, which
are typically capped at 3%, but graded annuities do not fully protect against inflation that exceeds
the annual cap.
The taxation of an annuity differs between the accumulation phase and the payout phase.
Deferred annuities receive favorable tax treatment in the accumulation phase. Returns on
investment are not taxed in the year they are earned. During the payout phase, taxation of
annuity income differs between payments taken as withdrawals and payments taken as a
life annuity. In either case, annuity income is taxed at ordinary income tax rates rather
than at capital gains tax rates.²⁸ The taxation of annuity income depends on whether the
income is received as
• a single lump sum,
• a series of withdrawals that are not annuitized, or
• a life annuity (either variable or fixed).
When funds are withdrawn as a lump sum, the amount of the distribution that exceeds the
amount the annuity owner invested is subject to taxation at the owner’s ordinary income
tax rate.²⁹ If money is taken out of the annuity in a series of withdrawals, each withdrawal
is considered to consist of investment earnings until all investment gains have been
withdrawn.³⁰ The taxation of annuity income is summarized in Table 4.
Each payment from a fixed annuity is treated as consisting partly of the investment gains, which
are taxable, and partly as a return of principal, which is not taxable. The proportion of each
payment that is excluded from taxable income is determined by dividing the amount that the
individual paid into the annuity by the total amount that would be paid out over an average life
²⁸
^T^h^e^long^-te^r^m^c^a^p^ita^{l g}^a^{ins ta}^x^r^a^te^{, a}^s^eⁿ^a^c^t^e^d^{in t}^h^e²⁰⁰³^Jo^{bs a}^{nd G}^r^ow^{th T}^a^x^Re^lie^f^Re^c^onc^ilia^{tion A}^c^{t, is 1}⁵^%^.
^Aⁿⁿ^uⁱ^t^y^wⁱ^t^h^d^r^aw^al^{s ar}^{e t}^a^xed^at^t^h^{e m}^a^rgiⁿ^al^t^a^{x rat}^e^f^o^{r o}^r^dⁱⁿ^a^ryⁱⁿ^co^m^e^,^w^hⁱ^c^h^co^u^l^d^b^e^hⁱ^gh^er^t^h^an^t^h^{e cap}ⁱ^t^a^l
^g^a^{ins ta}^x^ra^te^s.
²⁹^A^nnuitie^s^p^u^rc^ha^s^e^{d i}ⁿ^t^h^eⁱⁿ^divⁱ^dua^{l m}^a^rk^e^t^a^r^e^purc^h^a^s^e^d^w^{ith a}^f^te^r-ta^x^inc^o^m^e^.^T^h^e^am^ount^of^aⁿ^y^dis^t^ributioⁿ
^f^r^o^m^aⁿ^a^nnuity^tha^t^r^e^pr^e^s^eⁿ^ts^a^r^e^turⁿ^t^o^t^h^e^p^u^r^c^ha^s^e^r^of^his^or^h^e^r^ow^{n pr}^e^m^iu^m^pay^m^eⁿ^ts^is^not^ta^x^e^{d a}^s^e^c^ond
^tim^e^.
³⁰^For^e^x^a^m^ple^,^if^s^o^m^e^one^inv^e^s^t^{ed $}^25,⁰⁰^{0 i}ⁿ^a^de^f^e^r^r^e^{d a}^nnuity^a^{nd t}^h^e^v^a^lue^of^the^aⁿ^nui^ty^w^h^eⁿ^he^or^s^h^e^be^gⁱ^ns
^{to ta}^k^e^w^ithdr^a^w^a^l^s^is^$50,0⁰⁰^,^th^e^fⁱ^r^s^{t $25,}⁰⁰^{0 w}^ithdr^a^w^{n is}^ta^x^a^ble^a^s^or^dⁱ^na^r^y^inc^o^m^e^.^T^h^e^r^e^m^a^ining^$2^5,0⁰⁰^is
ⁿ^o^t^t^a^xed^b^ecau^{se i}^tⁱ^s^con^sⁱ^d^{ered a ret}^u^rn^o^f^p^rⁱⁿ^ci^p^a^l^t^o^t^h^e^p^u^r^c^h^aser.

expectancy, according to life tables published by the Internal Revenue Service. Each payment is
multiplied by this ratio to determine the fraction of the annuity payment that is not subject to
income taxes. For example, consider an individual who has paid a $100,000 premium for an
immediate annuity at age 65. In November 2008, a 65 year-old male would receive monthly
income of about $675 for a premium of $100,000. IRS life tables indicate that, on average, the ³¹
purchaser will receive annuity payments for 20 years. The total expected lifetime income from ³²
the annuity therefore would be $162,000. The proportion of each payment that would be
excluded from taxable income would be 100,000/162,000, or 61.7%. The other 38.3% percent of
each payment would be subject to income taxes.
With a variable annuity, income varies with the performance of the underlying investments. The
amount of income from a variable annuity that is excluded from taxable income is computed by
dividing the premiums paid for the annuity by the number of years that payments are expected to
be made to the annuitant. For a life annuity, this would be the annuitant’s life expectancy as
determined using IRS tables. In the case of a 65 year-old who had paid a premium of $100,000,
the amount of each monthly annuity payment that would be excluded from taxable income would ³³
be $416.
An exception to the taxation of annuity income was included in the Pension Protection Act of
2006 (P.L. 109-280). Beginning in 2010, withdrawals from annuity contracts that are used to pay
for qualified long-term care insurance premiums are not subject to income tax. However, the
investment in the annuity contract is reduced by the amount of the long-term care insurance
premiums. This means that a larger percentage of the future income received from the annuity
will represent investment gains and will be subject to income taxes.
Table 4. Tax Treatment of Annuities
^{Individual’s}^Investment
^{Type of A}^c^c^ount^{Contributions}^Returns^Withdrawals
^{Deferred An}^nuity^After-tax^Tax-Deferred^{Amounts in e}^xcess^{of contrib}^{utions are}
^{taxed as ordinary income}
^{Immediate Ann}^uity^After-tax^{Not applicable}^{Amounts in e}^xcess^{of contrib}^{utions taxed}
^{as ordinary income}
^{Defined Benefit Pension}^Varies^a^Tax-deferred^Amounts^{not previously included}ⁱⁿ
^{taxable income ta}^{xed as ordinary}^income
^Source:^{Congressional Researc}^h^Service.
^a.^{In t}^{he p}^{rivate-sector, employee}^{contributions are}^{rarely r}^e^q^{uired. Federal employee pension co}^ntributions
^{are made with afte}^{r-tax income.}^{Tax treatmen}^{t of pe}^{nsion contrib}^{ution by state}^{and local employees varies}
^{by locality.}
³¹
^Se^e^I^R^S^Public^a^tⁱ^on⁹³^9,^G^e^ne^r^a^{l Rule}^f^o^r^Pe^nsⁱ^ons^an^{d A}ⁿⁿ^uitie^s^,^T^a^ble^{5, p}²⁵^.
³²⁶⁷⁵^{x 12}^{x 20}^{= 16}^2,⁰⁰⁰^.
³³^Iⁿ^t^h^e^I^R^{S ta}^ble^s^{, the}ⁱⁿ^dⁱ^vⁱ^dua^l’^s^lif^e^e^x^pec^t^aⁿ^cy^a^t^{65 is}²⁰^y^e^a^r^{s, or}²⁴^{0 m}^onths^.¹^00,⁰⁰^0/²⁴^{0 =}⁴^16.

Consumer protections are intended to ensure that information used to sell an annuity is truthful,
and that individuals who purchase an annuity fully understand the future consequences with
respect to retirement income. The key challenge in the development and enforcement of
consumer protections is that some annuity products are regulated exclusively at the state level
while others are also regulated by federal agencies. Because state governments have primary
jurisdiction over regulation of fixed annuities, there is wide variation in regulation across states.
Further, while variable annuities are regulated by the federal Securities and Exchange
Commission (SEC), equity-index annuities, which are designed to track the performance of a
common stock index, such as the S&P 500 or the Russell 2000, are regulated primarily by the
states.
Like other insurance products, most annuities are regulated by the states. State laws govern the
organization and licensing of insurance companies and their agents and state insurance
departments oversee insurance company operations. These state laws and regulations also govern
marketing and sales practices as well as insurer requirements.
To help guide states in their oversight efforts, the National Association of Insurance
Commissioners (NAIC) has developed language for “model laws and regulations” to provide
guidelines for legislators to modify and adopt in their respective states. The NAIC Model Act has
not been uniformly adopted across states, thus leaving potential gaps in consumer protections. As ³⁴
of February 2008, 17 states have not adopted the NAIC model regulations on suitability. The
NAIC Model Suitability language requires insurance companies to give objective financial
information to potential purchasers, and it requires agents to use a standardized form to determine
whether an annuity would be suitable for the potential purchaser. Some state laws ban the use of
professional designations or titles – such as Senior Financial Advisor – that might mislead senior
consumers into thinking the advisor has special financial expertise related to the needs of older
consumers.
A similar problem exists with respect to disclosure requirements in annuity contracts. The NAIC
Annuity Disclosure Model Regulation requires certain information to be disclosed, including
information about premiums and how they are charged, a summary of the options and restrictions
for accessing money, and an outline of fees. According to the NAIC, 35 states have adopted the
NAIC disclosure regulation.
The states also play a role in protecting annuity owners against the insolvency of annuity insurers.
To do this, each state has a state guaranty association to provide a financial safety net for each
line of insurance and to ensure that coverage continues if an insurer becomes insolvent. State laws
require insurers to become members of the guaranty associations in every state in which they are
licensed to do business. The actual coverage for annuity contracts varies from state to state, but
cash values and annuity benefits are usually protected up to at least $100,000. However, coverage
is not provided for variable annuity contracts. Variable annuity contracts are held in separate
³⁴
^Am^e^r^ic^{an C}^o^unc^il^of^Life^Iⁿ^s^u^r^e^r^s^{, “}^Lⁱ^f^e^Ins^u^re^rs^{’ Initia}^tiv^e^{to Im}^p^r^ov^e^th^e^A^nnuity^Sa^le^s^Envⁱ^ronm^eⁿ^t,”^Fa^c^t^s^h^e^e^t^,
^Fe^br^ua^r^y²⁰⁰⁸^.

accounts by insurers and they are protected from the general creditors of the insurance company
in the event of insolvency. Although the Securities Investor Protection Corporation (SIPC)
protects against fraud in variable annuity sales, it does not provide any relief to investors whose
variable annuities decline due to falling prices in equity markets.
Because the assets underlying variable annuities are invested in equities, they are regulated by the
federal government through the Securities and Exchange Commission (SEC). Equity-index
annuities, which are based on market indexes, are not yet regulated by the SEC (see discussion
below). Federal securities laws require certain disclosure documents, including a prospectus, to
be given to investors. Certain disclosure documents must also be filed with the SEC. In addition,
written marketing materials, such as advertisements, are subject to federal regulation.
Federal law prohibits agents who sell variable annuities from making untrue statements of
material fact or failing to state a material fact that is necessary to prevent the statement from ³⁵
being misleading. Annuity agents also have a fiduciary duty to provide full and fair disclosure
of all material facts to their clients and their prospective clients, including all statements in
advertising materials. Currently, equity-index annuities are regulated by the states, rather then the
SEC. To address this inconsistency in regulation between variable and equity-index annuities, the
Securities and Exchange Commission has issued a proposed regulation that would extend federal
securities laws with respect to full and fair disclosure and sales practice protections to certain ³⁶
equity-index annuities.
Despite some of the potential advantages of individual life annuities, immediate annuities remain
a small part of retirement assets held in the U.S. Of those who purchased immediate annuities in ³⁷
2003, the median age of purchase was 70. The Internal Revenue Code requires owners of
individual retirement accounts to begin taking withdrawals from their accounts and including the
withdrawals in their taxable income no later than April of the year in which they reach age 70½.
Some owners of IRAs use immediate annuities to meet the requirement to take these “required
minimum distributions” from their retirement accounts. Without this requirement, demand for
annuities might even be lower.
There are several reasons why the demand for annuities is low despite the aging of the
population. Some potential purchasers may already feel they have a sufficient amount of
annuitized income from Social Security, and about a third of people 65 and older also have
annuity income from defined benefit pensions. Another reason may be the amount and non-
transparency of fees and expenses charged by insurance companies. Further, annuity contracts are
not easily canceled, and many individuals fear that after purchasing an annuity they may later
need a large sum of money to pay for unexpected expenses, such as long-term care or health
³⁵
^Se^c^tion¹⁷⁽^a⁾^of^the^Se^c^u^rⁱ^tⁱ^e^s^A^c^{t of}¹⁹³^4,^Se^c^tion¹⁰⁽^b⁾^of^the^E^x^c^h^aⁿ^g^e^A^c^{t a}^{nd R}^u^le¹^0b-^{5, a}^nd^Se^c^tion²⁰⁶^of
^the^Iⁿ^v^e^s^t^m^e^nt^A^d^vⁱ^s^o^r^s^A^c^{t o}^f¹⁹⁴⁰
³⁶^Se^e^C^R^S^R^e^por^{t R}^S²²⁹⁷^4,^Aⁿⁿ^u^itie^{s an}^{d t}^h^e^Se^c^u^ritie^s^an^{d Ex}^c^h^a^nge^Commissi^{on Pr}^op^ose^d^R^u^le¹^51A^,^by^B^a^ir^d
^We^b^e^l^.
³⁷^{M. Dri}ⁿ^k^w^a^t^e^r^{, “}^A^nnuitiz^a^tion^S^t^udy^{: P}^r^of^ile^{s a}^{nd A}^ttitude^s,”^L^I^MRA^Inte^rna^tiona^l,²⁰⁰³^.

expenses. Even among people who understand that it is important to insure against longevity risk,
some fear that they will die before reaching their normal life expectancy, and will end up “losing
the bet” with the insurance company that sold the annuity. Finally, recent adverse publicity about
deceptive sales practices in the annuity market has added to concerns among potential buyers of
immediate annuities.
Annuity providers impose a number of fees and expenses that are complex and are not transparent
to the annuity purchaser. Even a rather “simple” prospectus identifying the various fees can be ³⁸
more than 50 pages long.
Fees and expenses fall into three main categories: surrender charges, investment fees, and
insurance charges. Fees and expenses vary depending on the type of annuity (fixed or variable).
Both fixed and variable annuities have surrender charges, which are fees for cancelling the
contract before a specified number of years have passed. A typical surrender charge starts at 7%
of the premium in the first year of the contract and declines by 1% a year until it reaches zero.
However, a few companies have surrender charges of up to 15% to 25% of the annuity ³⁹
premium.
Variable annuities have two additional fees associated with managing assets. These are
investment management fees and insurance charges. Investment management fees cover the cost
of managing the different funds across investment accounts. Investment fees vary depending on
the type of investment portfolio chosen. Insurance charges include administration, sales
commissions, and mortality and expense charges. Mortality and expense charges average 1.15%
of the average value of investment and cover three components of the insurance guarantee:
• Mortality premium or guarantee of income over one’s lifetime;
• Death benefit to protect beneficiaries (also called survivor benefit); and,
• The cost of the minimum income guarantee.
These fees vary by product design. Typically, a fixed annuity with a joint and survivor option is
subject to all three components. However, a variable annuity without a joint and survivor option
and no minimum guarantee would only be subject to the mortality premium.
It is difficult for consumers to identify and understand each fee charged for an annuity. Each
insurer has a different format for disclosing information. The insurance industry has recognized
this problem and has begun to standardize fee disclosure. A group of insurance organizations is
working to develop a simple, standardized disclosure document that presents information about ⁴⁰
fees in a consumer-friendly manner.
³⁸
^B^e^st^{’s R}^evi^ew^{, “}^T^{is a}^Gⁱ^f^t^{to be}^Sⁱ^m^p^le^{: Com}^p^le^x^A^nnuitie^{s Sc}^a^r^e^Off^{Both Buy}^e^{rs a}^{nd A}^d^vⁱ^se^{rs, S}^o^the^Iⁿ^d^u^stry^is
^Off^e^ring^L^e^{ss Inti}^mⁱ^da^ting^Pro^d^u^c^ts,”^A^p^{ril 1, 2}⁰⁰⁶^.
³⁹^T^e^s^tⁱ^m^on^y^of^Minne^s^o^ta^A^ttorⁿ^e^y^G^e^ne^r^a^{l L}^o^rⁱ^Sw^aⁿ^s^{on B}^e^f^o^r^e^t^h^e^Se^na^te^S^p^e^cⁱ^a^l^C^o^m^m^itte^e^{on A}^g^ing^on
^“^A^dv^is^ing^Se^nior^s^A^{bout T}^h^eⁱ^r^Mone^y^:^W^{ho is}^Q^u^a^lif^ie^{d a}ⁿ^d^W^{ho is}^N^o^t?^”^Se^pte^m^be^r^{5, 2}⁰⁰⁷^.
⁴⁰^Me^m^b^e^r^s^of^this^g^r^{oup i}ⁿ^c^l^u^d^e^A^m^e^r^ic^aⁿ^Counc^il^of^Lⁱ^fe^Ins^u^re^rs^{, N}^a^tiona^{l A}^s^s^o^cⁱ^a^tion^of^V^a^ria^b^le^A^nnuitie^s^,
^N^a^tiona^{l A}^s^s^o^cⁱ^a^tion^of^Iⁿ^s^u^r^a^nc^e^a^{nd F}ⁱ^na^nc^ia^{l A}^d^vⁱ^s^o^r^s^{, a}ⁿ^{d t}^h^e^N^a^tiona^{l A}^s^s^o^cⁱ^a^tion^of^I^nde^peⁿ^d^e^{nt L}ⁱ^f^e^B^r^ok^e^r^a^g^e
^Agen^ts.

Another factor affecting the cost of annuities is that people who buy annuities tend to be those
who expect to live longer than average. A person who chooses to purchase an annuity may have
information about his or her health, habits, or family history that the insurance company does not
have regarding their risk of living longer than average. This phenomenon, called “adverse
selection,” leads to higher annuity premiums than insurers would otherwise have to charge if
longevity risk were spread over the entire population. Estimates of the cost of adverse selection
vary. Some studies have found that adverse selection reduces income to annuity purchasers by 4 ⁴¹
cents to 10 cents per dollar of premiums paid. A more recent study defined “potential
annuitants” more narrowly to only include those with sufficient wealth to purchase an annuity.
When re-defined in this manner, potential annuitants tend to live considerably longer than
average and thus would receive a better deal from an annuity than the average person. According
to this analysis, the impact of adverse selection on annuity prices is only about half as great as ⁴²
previously estimated, or about 2 cents to 5 cents per premium dollar. If participation in
individual annuities were broader, the effect of adverse selection would be reduced and
annuitants’ income would be higher.
Once an individual purchases an immediate annuity, the decision is not easily reversible. Most
states require a 10-day look back period during which a buyer can change his or her mind, but
after this, canceling an annuity contract will result in substantial surrender charges. Part of the
lack of flexibility in annuity contracts was recently addressed in the Pension Protection Act of
2006, which allows funds used to purchase an annuity to be withdrawn tax-free to buy long-term
care insurance. It is important to note that long-term care insurance must be purchased well in
advance of actually needing long-term care services. Annuity owners would have to make the
decision to purchase long-term care insurance in the early years of the payout phase.
Dying Before Getting Full Value. Annuity buyers pay for the insurance component of the annuity,
which guarantees a monthly income no matter how long the annuitant lives. Some people are
reluctant to purchase an annuity out of fear that they will die before they get back the premiums
that they paid into it. Joint and survivor annuities and term-certain annuities can assure that
annuity payments will continue even if the purchaser dies earlier than he or she expected, but
these options reduce the monthly payments that the annuitant receives while he or she is living.
Adverse Publicity and Lack of Knowledge About Annuities. Another factor affecting current
demand for annuities may be adverse publicity surrounding false advertising and deceptive sales
practices employed by insurance agents selling equity-index annuities. These practices may have
led some consumers to avoid all annuity products. Equity-index annuities, however, currently
account for only 11% of annuity sales. Further, recent proposals by the SEC to strengthen
regulations for sales of equity-index annuities may help to alleviate consumers’ concerns in the
future.
⁴¹
^Mitc^he^ll,^O^liv^ia^{, J}^a^m^e^s^P^o^te^r^b^a^,^Ma^r^k^W^a^r^s^haw^s^ky^{, a}^{nd J}^e^f^f^r^e^y^B^r^ow^{n, “}^N^ew^Ev^ideⁿ^c^e^{on t}^h^e^M^o^ne^y^’^s^W^o^r^t^{h of}
^I^ndivⁱ^d^u^a^l^A^nnui^tie^s^.^”^Am^e^r^ic^{an Ec}^onom^ic^Re^vⁱ^e^w^{, 89(}⁵⁾^,¹⁹⁹⁹^.
⁴²^W^e^b^b^,^Aⁿ^t^h^on^y^.^“Is^A^d^vers^{e S}^e^l^ectⁱ^oⁿⁱⁿ^t^h^{e A}ⁿⁿ^uⁱ^t^y^M^a^rket^A^Bi^{g P}^r^o^b^l^em^{?” Issu}^{e Bri}^e^f^,^Cen^t^{er f}^o^{r Ret}ⁱ^r^e^m^en^t
^R^e^s^e^a^r^c^h^a^t^B^o^s^t^{on C}^o^lle^g^e^{, J}^a^nu^a^r^y²⁰⁰⁶^{, N}^u^m^b^e^r⁴⁰^.

Although annuities offer protection from longevity risk and investment risk, relatively few people
use their retirement savings to purchase an annuity. Most people choose instead to take periodic
withdrawals from their retirement accounts. Individuals who purchase life annuities transfer the
responsibility for managing assets and the risk of outliving their assets to an insurance company.
In contrast, retirees who “self-annuitize” take on the responsibility of managing their investments
and also the risk of living longer than average. Annuity purchasers, however, give up control over
the assets that they use to purchase their annuities, while those who take periodic withdrawals
have the money in their retirement accounts available to meet large, unexpected expenses that
may arise during retirement.
For those who choose to take periodic withdrawals, there are two basic approaches to taking
money out of their retirement accounts. The first approach attempts to “smooth” consumption
over the period of retirement through equal (inflation-adjusted) withdrawals each year. This
method provides a steady income from year to year, but as the examples presented in this report
will illustrate, it can be difficult to choose a rate of withdrawal that can be sustained in the face of
uncertain life expectancy and variable rates of return on investment. Another strategy for drawing
down retirement assets is to take withdrawals that are based on the individual’s remaining life
expectancy in the year that each withdrawal is taken. This method of withdrawing money from a
retirement account is prescribed by law for the required minimum distributions that all owners of
traditional IRAs and retired owners of 401(k) accounts must begin taking after they reach age ⁴³
70½ . Under this approach, it is unlikely that the individual will exhaust his or her savings, but
withdrawals can vary substantially from year to year. This can make planning and budgeting
difficult.
An individual who chooses to take periodic withdrawals might want to have some idea how likely
his or her chosen strategy is to succeed. The first step in such an assessment is to define success.
Financial planners often advise clients that they should adopt a method of withdrawing retirement
funds that will result in a high probability that their savings will last 30 to 40 years. Assuming
that 40 years is a reasonable upper bound for the number of years that a retirement account might
need to last, the next task for the retiree is to determine the minimum probability of success that
he or she is willing to accept. There is no fixed standard for the minimum probability of success
that a retiree should be willing to accept for the annual rate of withdrawal that he or she chooses.
For purposes of illustration, we have highlighted in the tables that follow the combinations of
initial withdrawal rates and investment allocations that resulted in an account balance lasting for a
given number of years (or to a given age) in 95.0% or more of our simulations.

One way to evaluate the likely success of a withdrawal strategy is to determine the probability
that the retiree’s assets will last for at least a specific number of years, assuming that rates of
⁴³
^Se^e^{26 U}^.^S.C^.^§⁴⁰¹⁽^a⁾⁽⁹⁾^aⁿ^d^§4⁰⁸⁽^a⁾⁽⁶⁾^a^{nd C}^R^{S R}^e^p^o^r^t^R^L³¹⁷⁷^0,^I^ndivⁱ^du^{al Re}^tir^e^m^eⁿ^{t Ac}^c^o^unt^s^an^{d 4}⁰¹⁽^k⁾
^Plans^:^Ear^l^y^W^ith^dr^aw^als^aⁿ^d^Re^quir^e^{d D}ⁱ^s^t^rⁱ^bu^tio^ns^{, by}^P^a^tric^k^Purc^e^ll.

return on investment will vary from year to year. To estimate this probability, CRS developed a
model that estimates how long a sum of money will last, assuming a particular initial rate of
withdrawal and the probable distribution of annual rates of return on investment. The model
estimates the annual rate of return on investment through a Monte Carlo simulation process in
which the rate of return in each year is based on the distribution of annual total returns on stocks ⁴⁴
and bonds over the 82 years from 1926 through 2007. (See Appendix A for a description of
Monte Carlo simulation processes.)
It is important to note that an annual rate of withdrawal that minimizes the risk of exhausting a
retirement account – whether by delaying the initial withdrawal or by taking “small” annual
withdrawals – will increase the likelihood that the account will have substantial assets remaining
at the time of the owner’s death. Delaying the initial withdrawal and taking relatively small
withdrawals both help to preserve assets in the event that the individual outlives his or her normal
life expectancy or experiences below-average rates of investment return. However, for the
individual who lives to his or her normal life expectancy and experiences average rates of return
on investment, the end result of successfully reducing the risk of exhausting his or her account
may be a substantial unexpended account balance at the time of death.
CRS estimated the probability that assets would last for five periods of time ranging from 20
years to 40 years at five initial withdrawal rates ranging from 4.0% to 6.0% of the value of the
account when the first withdrawal is taken. We chose this range of withdrawal rates because “a
large body of research on ‘safe’ withdrawal rates for individuals has determined that a real
withdrawal rate in the neighborhood of 4 percent of the initial retirement portfolio has a ‘low’ ⁴⁵
chance of running out of money,” and because recent research has demonstrated that initial rates ⁴⁶
of withdrawal equal to 7.0% or more are very likely to exhaust the assets too rapidly. In the
estimates presented in the following tables, the withdrawal rate is stated as the percentage of the
initial withdrawal from the account. Subsequent withdrawals are equal to the first withdrawal in
constant (inflation-adjusted) dollars, but they may represent a different percentage of the ⁴⁷
remaining account balance.
⁴⁴
^W^e^us^e^d^the^r^e^a^l^aⁿⁿ^u^a^l^r^a^te^s^of^t^o^ta^{l r}^e^turⁿ^oⁿ^t^h^e^Staⁿ^da^r^d^a^nd^P^oor^’^s⁵⁰^{0 in}^de^x^of^c^o^m^m^{on s}^t^oc^k^s⁽^a^{nd its}
^pr^e^d^e^c^e^s^s^o^r^S&^Pⁱ^nde^x⁾^aⁿ^d^A^A^A^-^r^a^t^e^{d c}^o^r^por^a^t^e^bo^nds^f^r^om¹⁹^{26 t}^h^r^o^ug^h²⁰⁰⁷^{to r}^e^pr^e^s^eⁿ^{t the}^r^a^te^s^of^r^e^turⁿ^oⁿ
^inv^e^s^t^m^e^{nt. T}^h^e^Monte^C^a^r^l^{o s}ⁱ^m^u^la^tio^ns^w^e^r^e^pe^r^f^or^m^e^{d w}^{ith P}^a^li^s^a^de^C^o^r^por^a^t^io^n’^s^@^R^I^S^K^sⁱ^m^u^la^{tion s}^o^f^t^w^a^r^e^.
⁴⁵^J.^J.^S^pⁱ^t^zer,^J.^C.^S^t^ri^et^er,^and^S^.^Sⁱⁿ^g^h^,^“G^uⁱ^d^e^lⁱⁿ^e^{s f}^o^{r W}ⁱ^t^h^d^r^awal^Rat^e^{s an}^d^P^o^r^t^f^o^lⁱ^o^S^a^f^e^t^y^Du^riⁿ^g^Retⁱ^r^emen^t^,^”
^J^ourⁿ^a^{l o}^f^Fi^na^nc^ial^Plaⁿⁿⁱ^ng^{, v}^o^l.²⁰⁽¹⁰⁾^,⁽^O^c^t^obe^r²⁰⁰⁷⁾^.
⁴⁶^Spitz^e^r^,^Strⁱ^e^t^e^r^{, a}ⁿ^{d Si}^ng^h^note^t^h^a^t^sⁱ^m^u^la^tions^of^w^ithdr^a^w^a^l^r^a^t^e^s^of^7.0%^or^m^o^r^e^of^the^a^c^c^oun^t^ba^la^nc^e
^“iⁿ^v^ari^a^b^l^y^re^su^l^t^e^dⁱⁿ^unⁿ^accep^t^a^b^l^{e ru}^no^u^t^rat^e^s.^”
⁴⁷^T^h^{is is m}^a^the^m^a^tic^a^l^l^y^e^quiv^a^le^{nt to i}ⁿ^c^r^e^a^s^ing^aⁿⁱⁿ^itia^l^nom^ina^l^w^ithdra^w^a^l^by^the^e^s^ti^m^a^te^{d a}^nnu^a^l^ra^te^of^c^h^aⁿ^g^e
ⁱⁿ^t^h^{e co}ⁿ^s^u^m^{er p}^rⁱ^{ce i}ⁿ^d^e^x.^A^s^S^pⁱ^t^zer,^et^al^.⁽²⁰⁰⁷⁾^no^t^e^:^“S^o^m^{e au}^t^h^o^r^{s u}^s^edⁿ^o^mⁱⁿ^al^rat^e^{s o}^f^ret^u^rⁿ^an^{d t}^h^eⁿ
^ad^j^u^st^ed^t^h^{e w}ⁱ^t^h^d^r^aw^al^{s each}^y^e^{ar f}^o^{r i}ⁿ^f^l^atⁱ^oⁿ^su^{ch t}^h^at^t^h^{e w}ⁱ^t^h^d^r^aw^al^a^m^{ount w}^a^s^the^s^a^m^e^am^o^unt^{in r}^e^a^l^te^r^m^s^.
^W^e^c^hos^e^{to us}^e^r^e^a^l^d^o^lla^r^s^thr^o^u^g^{hout a}^{nd a}^v^oi^{d t}^h^e^aⁿⁿ^u^a^lⁱⁿ^f^l^a^{tion a}^d^jus^t^m^e^{nt. T}^h^e^outc^o^m^e^s^of^eithe^r^pr^oc^e^s^s
^s^houl^d^be^the^s^a^m^e^ir^r^e^s^p^e^c^tiv^e^o^f^w^h^e^r^e^the^a^d^jus^t^m^e^{nt f}^o^r^inf^l^a^{tion is}^m^a^de^{, w}^h^e^t^he^r^{in the}^w^ithdr^a^w^a^l^r^a^te^or^{in the}
^r^a^te^of^r^e^turⁿ^e^a^r^ne^d^by^the^inv^e^s^t^m^e^nt.”

Many financial advisors recommend that retirees should keep 50% or more of their retirement
savings invested in a diversified portfolio of stocks because stocks have historically achieved a
higher long-run average rate of return than bonds. The higher long-run average rate of return on
common stocks compared to bonds acts as a form of longevity insurance for the retiree.
Generally, advisors recommend that the remainder of assets should be invested in bonds and
money market securities that are less susceptible than stocks to large capital losses.
In our analysis, we simulated withdrawals from two portfolios. In one set of simulations, retirees
allocated 65% of assets to the Standard & Poor’s 500 index of stocks and invested the remainder
in AAA-rated corporate bonds. In the second set of simulations, retirees allocated 35% of assets
to the Standard & Poor’s 500 index of stocks and invested the remainder in AAA-rated corporate
bonds. In all of the simulations, withdrawals were taken at the beginning of each year. Accounts
were re-balanced annually so that the portfolio would start each year at the chosen allocation
between stocks and bonds. The model also took into account the correlation between annual ⁴⁸
returns on stocks and bonds. The effects of account fees and income taxes were ignored for ⁴⁹
purposes of this analysis.
The data presented in Table 5 illustrate the likelihood that savings will last for at least a given
number of years under several initial rates of withdrawal and under the two investment portfolios
described above. Panel 1 of Table 5 shows the probability that a retirement account will last for at
least a given number of years, assuming that 65% of the assets in the account are invested in
stocks represented by the Standard & Poor’s 500 index and 35% of the assets are invested in
AAA-rated corporate bonds. Panel 2 of Table 5 shows the probability that savings will last for at
least a given length of time, assuming that 35% of the assets are invested in stocks and 65% of the ⁵⁰
assets are invested in bonds.
The results presented in Table 5 indicate that at an initial withdrawal rate of 4.0%, there is a
98.5% probability that an account invested in this portfolio will last for at least 20 years. The
longer the period of time over which withdrawals are taken, the lower the likelihood that a given
rate of withdrawal will continue to be successful. At a 4.0% initial rate of withdrawal, there is a
92.5% chance that the account will last for 30 years or more, and an 86.8% chance that it will last
for at least 40 years.
⁴⁸
^O^v^e^r^the^pe^rⁱ^o^d^f^r^om¹⁹²⁶^thr^o^u^g^h²⁰^07,^the^c^o^r^r^e^la^tion^c^o^e^f^fⁱ^cⁱ^{ent f}^o^r^the^r^e^a^l^r^a^te^s^of^r^e^turⁿ^oⁿ^t^h^e^S&^P⁵⁰^{0 i}^nde^x
^a^{nd A}^A^A^-^r^a^te^{d long}^-^t^e^r^m^c^o^r^por^a^t^e^bon^ds^w^a^s^.236.
⁴⁹^In^revⁱ^ewⁱⁿ^g^th^{e literatu}^{re o}ⁿ^reti^re^m^eⁿ^t^acc^{ount w}^ithdr^a^w^a^l^s^,^w^e^f^oun^{d t}^h^a^t^r^e^s^e^a^r^c^h^s^t^ud^ie^s^w^e^r^e^abou^{t e}^v^eⁿ^ly
^divⁱ^de^d^be^tw^e^eⁿ^thos^e^tha^t^sⁱ^m^u^la^te^{d the}^e^f^f^e^c^t^s^of^f^e^e^s^a^{nd ta}^x^e^s^{and t}^hos^e^t^h^a^t^dⁱ^d^no^{t. Si}^nc^e^the^pu^r^pos^e^of^o^u^r
^aⁿ^a^l^y^s^is^w^a^{s to illustra}^te^t^h^e^e^f^f^e^c^t^{s of}^ra^te^{s of}^w^ithdr^a^w^a^l^{, ra}^te^{s of}^re^turn^on^inv^e^stm^e^{nt, a}^{nd lif}^e^e^x^pe^c^t^aⁿ^c^y^on
^a^c^c^ount^ba^la^nc^e^s^{, w}^e^de^cⁱ^de^{d to f}^o^c^u^s^oⁿ^t^h^e^s^e^v^a^rⁱ^a^b^le^s^a^{nd ig}^nor^e^f^e^e^s^a^{nd ta}^x^e^s^.
⁵⁰^For^t^h^e^s^e^sⁱ^m^u^la^tions^{, t}^h^eⁱⁿⁱ^tia^l^a^c^c^ount^ba^la^nc^e^w^a^s^as^s^u^m^e^{d to}^be^$1⁰⁰^,0^00;^h^o^w^e^ve^r^,^the^r^e^s^u^lts^a^r^e^inde^pe^nde^nt
^of^the^init^ia^{l ba}^la^nc^e^aⁿ^{d a}^p^ply^e^qua^lly^{to othe}^r^a^m^ounts^.

For any given number of years, the likelihood of an account lasting for at least that length of time
is lower for higher initial rates of withdrawal. While there is a 98.5% chance that an account will
last for at least 20 years at a 4.0% initial rate of withdrawal, this probability drops to 94.1% for a

5.0% initial rate of withdrawal and to 84.2% for a 6.0% initial rate of withdrawal.

Panel 2 of Table 5 shows the probability that a retirement account in which 35% of assets are
invested in stocks and 65% of assets are invested in bonds would last for at least 20, 30, or 40
years. The results of the simulations indicate that for periods of time of 20 years or more, the
likelihood of exhausting a retirement account is higher for an account with a 65% allocation to
bonds compared to an account with a 65% allocation to stocks.
The likelihood that an account would last for at least 20 years is slightly higher for an account
with a 65% allocation to bonds compared to an account with a 65% allocation to stocks. This
result occurs because a portfolio that is more heavily invested in stocks has a greater chance than
a portfolio mainly invested in bonds of experiencing a large capital loss. If this happens in the
early years of retirement, the account may be depleted rapidly. Over longer periods of time,
however, the probability of running out of money is substantially higher with a portfolio in which
65% of assets are invested in bonds compared to a portfolio in which 65% of assets are invested
in stocks because of the lower expected average annual rate of return on bonds.
Table 5. Estimated Probability a Retirement Account Will Last
for at Least a Specific Number of Years
^{Initial Annual Withdra}^{wal f}^r^{om Retirement Acco}^unt^Probability
^{that Money}
^{Will Last:}^{4.0% 4.5% 5.0%}^{5.5% 6.0%}
^{Panel 1: Inves}^{tment Portfoli}^{o = 65% Stocks, 35% Bonds}
^{20 yea}^{rs or more}^{98.5 96.9}^{94.1 89.8}^84.2
^{25 yea}^{rs or more}^95.7^{92.3 87.0}^{80.7 72.3}
^{30 yea}^{rs or more}^92.5^87.2^80.5^72.6^63.3
^{35 yea}^{rs or more}^89.6^82.7^75.3^66.4^56.3
^{40 yea}^{rs or more}^86.8^78.3^71.0^61.7^51.4
^{Panel 2: Inves}^{tment Portfoli}^{o = 35% Stocks, 65% Bonds}
^{Probability that money will last:}
^{20 yea}^{rs or more}^{99.7 98.9 96.4}^{92.2 84.8}
^{25 yea}^{rs or more}^97.7^{94.5 87.8}^{78.3 65.2}
^{30 yea}^{rs or more}^94.0^87.3^77.0^64.1^49.5
^{35 yea}^{rs or more}^89.4^79.7^66.9^53.2^38.8
^{40 yea}^{rs or more}^84.3^73.2^58.9^45.6^31.1
^Source:^{Congressional Researc}^h^Service.
^Notes:^Probabil^{ities >= 95.0% a}^r^e^{in italics.}

The estimates presented in Table 5 illustrate the probability that a retirement account will last for
at least a given number of years, assuming a particular initial rate of withdrawal, a specific
allocation of investments between stocks and bonds, and the estimated annual rates of return on
investment. These results are likely to underestimate the likelihood that a particular strategy will
succeed because they do not account for individual mortality. Because not all account owners will
live until the end of a fixed interval of time, the probability of an account having money in it at
the earlier of either the account owner’s death or the end of the interval is greater than the
probability of the account having money in it at the end of the interval. To ignore the possibility
of the account owner dying in any year will result in underestimating the probability that a
particular rate of withdrawal will sustain the account throughout the owner’s lifetime. As other
researchers have noted, the relevant consideration in planning retirement withdrawals is “the
probability of running out of money in the retirement life span, whether that span is shorter or ⁵¹
longer than a predetermined number of years.”
Estimates of the likelihood that a retirement account will last for a particular number of years
should include the probability that the account owner will survive for that number of years. This
can be done by including in the model of retirement withdrawals the probability of the individual
surviving from one year to the next. To incorporate the effect of mortality on the probability that a
retiree will exhaust his or her retirement account before the earlier of either the retiree’s death or
the attainment of a particular age, CRS added two variables to its model. One variable accounts
for the individual’s age at retirement and in each succeeding year, and the other makes each ⁵²
annual withdrawal conditional on the individual having survived from one year to the next. The
probability of survival from year to year was based on male and female life expectancies taken ⁵³
from cohort life tables. An individual’s withdrawal strategy was considered to have been
successful if there was a 95.0% or higher probability that he or she had a positive account balance
in the year of death or, if still living, at the ages of 80, 85, 90, 95, and 100.
Table 6, Table 7, and Table 8 show the estimated probabilities that the retirement accounts of
men and women who retire at ages 60, 65, or 70 will last until the ages of 80, 85, 90, 95, and 100, ⁵⁴
taking into account the probability of the individual dying in each year. The initial withdrawal
rates range from 4.0% to 6.0% and subsequent withdrawals are assumed to be equal in real value
⁵¹
^R.G^.^Stout^aⁿ^d^{J.B. M}^itc^he^{ll, “}^D^yⁿ^a^mⁱ^c^Re^tire^m^eⁿ^{t W}^ithdra^w^a^l^Plaⁿⁿⁱ^ng^,^Fⁱ^naⁿ^cⁱ^a^l^S^e^rvi^ces^R^evi^e^w^{, v}^o^l.¹⁵⁽²⁾^,
⁽^S^um^m^e^r²⁰⁰⁶⁾^.^T^h^e^a^u^th^or^s^f^u^r^t^he^r^no^te^tha^t^,^“^b^y^inc^o^r^por^a^tⁱⁿ^g^th^e^unc^e^r^ta^{in r}^e^tir^e^m^eⁿ^{t lif}^e^s^p^aⁿ^,^[^a^m^ode^{l of}^pha^s^e^d
^w^ithdra^w^a^l^s]^g^e^ne^ra^te^{s a}^m^o^re^m^e^aⁿ^ing^f^{ul pro}^b^a^b^ility^of^fⁱ^na^nc^ia^{l ruin.”}^Sto^u^{t a}ⁿ^{d M}^itc^he^{ll’s a}ⁿ^a^l^y^s^{is look}^e^d^a^t^one
^por^tf^oli^o^c^ons^is^tⁱ^ng^of⁶⁵^%^s^t^oc^k^s^a^nd^35%^b^oⁿ^d^s^,^aⁿ^{d t}^h^eⁱ^r^e^s^tim^a^t^e^s^w^e^r^e^ba^s^e^{d on a}^uⁿ^is^e^x^lif^e^ex^pe^c^t^aⁿ^cy^ta^ble^.
^C^R^S^te^s^t^e^d^tw^{o p}^o^r^t^f^o^lios^,^one^of^65%^s^t^oc^k^s^a^nd^one^of^35%^s^t^oc^k^s^{, a}^{nd w}^e^us^e^d^s^e^pa^r^a^te^lif^e^e^x^pe^ctaⁿ^c^y^ta^ble^s^f^o^r
^m^e^{n a}^{nd w}^o^m^e^n.
⁵²^In^each^si^m^u^l^a^tⁱ^oⁿ^,^t^h^{e i}ⁿ^di^vi^d^u^a^l^’^{s p}^r^ob^abⁱ^lⁱ^t^y^o^f^h^a^viⁿ^g^dⁱ^ed^b^e^t^w^e^eⁿ^{age x an}^d^{age x}⁺¹^w^a^{s co}^mp^ared^t^o^{a ran}^d^o^m
^num^be^{r g}^e^ne^ra^te^{d by}^the^m^ode^{l. I}^f^the^ra^ndom^num^be^{r w}^a^s^g^r^e^a^t^e^r^thaⁿ^t^h^e^pr^oba^b^ility^of^ha^vⁱ^ng^die^d^{, t}^h^e^sⁱ^m^u^la^tion
^c^onti^nue^{d f}^o^r^aⁿ^ot^he^r^y^e^a^r^{. I}^f^the^r^a^ndom^num^be^r^w^a^s^lo^w^e^r^thaⁿ^t^h^e^pr^o^b^a^b^il^ity^of^de^a^t^{h, the}^sⁱ^m^u^la^{tion s}^t^op^pe^d.
⁵³^M^a^l^e^an^d^f^e^mal^e^lⁱ^f^{e e}^x^p^ect^an^ci^e^s^at^each^age^w^e^r^e^t^a^ken^f^r^o^m^“Uⁿⁱ^t^e^d^S^t^at^{es L}ⁱ^{fe T}^a^b^l^es,^2004,”^N^a^tio^nal^Vit^a^l
^Statis^tⁱ^c^s^Re^por^ts^,^v^o^l.⁵⁶⁽⁹⁾^{, U}^.^S^.^D^e^pa^r^t^m^e^{nt of}^H^e^a^{lth a}^{nd H}^u^m^a^{n Se}^r^v^ic^e^s^{, C}^e^nte^r^s^f^o^r^Dⁱ^s^e^a^s^e^C^ontr^o^{l a}ⁿ^d
^P^r^even^tⁱ^oⁿ^,^Natⁱ^oⁿ^a^l^Cen^t^{er f}^o^{r Heal}^t^h^S^t^atⁱ^s^tⁱ^c^s,^(Decem^b^e^r²⁰⁰⁷⁾^,^a^v^a^ila^ble^a^t^http:^//w^w^w^.c^dc^.g^ov^/ⁿ^c^h^s^/^da^ta^/nv^s^r^/
^nv^s^r^56/^nv^s^r^56_⁰⁹^.p^df^.
⁵⁴^R^e^la^tiv^e^l^y^f^e^w^pe^ople^ta^k^e^w^ithdr^a^w^a^l^s^f^r^o^m^r^e^tir^em^eⁿ^{t a}^c^c^ounts^be^f^o^r^e^a^g^e^{60 b}^ecau^{se w}ⁱ^t^h^d^r^awal^{s f}^r^o^m^a
^tra^d^itio^na^{l IRA}^{or a}⁴^01(k⁾^plaⁿ^t^a^k^e^{n be}^f^o^re^a^g^e^59½^a^r^e^s^ubje^c^t^t^o^a¹⁰^%^a^dditⁱ^oⁿ^a^l^ta^x^e^x^c^e^p^{t f}^o^{r c}^e^r^ta^{in situa}^tio^ns
^de^fⁱ^ne^{d in la}^w^a^t²⁶^U^.^S.C^.^§⁷²⁽^t)^{. Se}^c^tio^{n 4}⁰¹⁽^a⁾⁽⁹⁾^of^the^Iⁿ^te^rⁿ^a^l^R^e^v^e^nue^C^ode^r^e^q^u^ir^e^s^ow^ne^r^s^o^f^tr^a^d^itiona^{l I}^R^A^s
^a^{nd r}^e^tir^e^d^ow^ne^r^s^of⁴⁰¹⁽^k⁾^plaⁿ^s^{to s}^t^a^r^{t ta}^kⁱ^ng^dⁱ^s^t^rⁱ^b^u^tio^ns^a^f^te^r^the^y^r^each^a^g^{e 7}⁰^½^.

(i.e., adjusted for inflation) to the initial withdrawal.⁵⁵ The tables show the estimated probabilities
of success for two portfolios. In one portfolio, 65% of assets are invested in stocks and 35% in
bonds, and in the other portfolio, 65% of assets are invested in bonds and 35% in stocks.
The data presented in Table 6 show the estimated probabilities of a retirement account lasting
until ages 80, 85, 90, 95, and 100 for men and women retiring at age 60. Table 5 showed that at a
4.0% initial rate of withdrawal from an account invested 65% in stocks and 35% in bonds, there
is a 98.5% chance that a retirement account will last for at least 20 years. The results presented in
Table 6show that under the same set of assumptions, but incorporating the effects of mortality, a
man retiring at 60 has a 99.1% chance that his retirement account will last until at least age 80,
while for a woman retiring at age 60 there is a 98.9% chance that her account will last until at
least age 80. In this case, the probabilities are almost equally high in both Table 5 and Table 6,
and there is little difference in the probabilities of success between and women. Both of these
results change for the probability of success at later ages.
Table 5 showed that at a 4.0% withdrawal rate, the probability of a retirement account lasting for
at least 30 years was 92.5%. The data in Table 6 show that once the effects of mortality are taken
into consideration, there is a 97.3% chance that a man who retires at 60 and takes an initial
withdrawal of 4.0%, will still have some money in the account at age 90, while a woman retiring
at age 60 and taking an initial withdrawal of 4.0% has a 96.1% chance of still having money in ^th
her account on her 90 birthday. The probability that a woman will still have money in her
account at any given age is lower than the probability for a man because a woman has a higher
probability of having survived to that age. (See Appendix B.)
In simulations representing retirement at age 60, a withdrawal rate of 4.0% was successful in
95.0% or more of simulations for both men and women under both investment portfolios at all
ages up to 100. (See Table 6.) A withdrawal rate of 6.0% failed to achieve a 95.0% success rate
for either men or women under either investment portfolio even just to age 80. For both men and
women retiring at age 60, a withdrawal rate of 5.0% or higher carries a high risk that their
retirement accounts will be exhausted before they have attained their normal life expectancies.
Table 7 and Table 8 show that, compared to retiring at age 60, delaying retirement until 65 or 70
can substantially increase the likelihood that an individual will not exhaust his or her retirement
account before he or she dies. In simulations representing retirement at age 65, withdrawal rates
of 4.0% and 4.5% were successful in 95.0% or more of simulations for both men and women
under both investment portfolios at all ages up to 100. (See Table 7.) A withdrawal rate of 6.0%
achieved a 95.0% success rate under either investment portfolio for both men and women only up
to age 80. For men who retire at age 65, a withdrawal rate of 5.5% or higher carries a substantial
risk that their retirement accounts will be exhausted if they live to age 90 or older. For women
who retire at age 65, a withdrawal rate of 5.0% or higher carries a substantial risk that their
retirement accounts will be exhausted if they live to age 90 or older.
In simulations representing retirement at age 70, withdrawal rates of 4.0%, 4.5%, and 5.0% were
successful in 95.0% or more of simulations for both men and women under both investment
portfolios at all ages up to 100. (See Table 8.) A withdrawal rate of 5.5% was successful up to age
⁵⁵
^A^s^w^ith^th^{e estim}^{ates sh}^o^wⁿⁱⁿ^T^a^b^l^{e 5}^,^f^o^{r t}^h^{e resu}^lts^p^r^esen^tedⁱⁿ^T^a^b^l^{e 6}^,^T^a^b^l^{e 7}^,^an^d^T^a^b^l^{e 8}^,^th^{e in}^{itial acco}^uⁿ^t
^ba^la^nc^e^w^a^{s a}^ssu^m^e^{d to be}^$1^00,⁰⁰⁰^{, b}^u^t^the^re^{sults a}^r^eⁱ^nde^pe^nde^{nt of}^theⁱⁿ^itia^l^ba^la^nc^e^aⁿ^d^w^oul^{d a}^l^{so a}^p^ply^to
^o^t^h^e^{r i}ⁿ^{itial acco}^uⁿ^t^b^a^lan^ces.

100 in 94.7% or more of cases for men under either investment portfolio, but succeeded in 95.0%

or more of cases only to age 90 for women. For men who retire at age 70, a withdrawal rate of
6.0% or higher carries a substantial risk that their retirement accounts will be exhausted if they
live to age 95 or older. For women who retire at age 70, a withdrawal rate of 5.5% or higher
carries a substantial risk that their retirement accounts will be exhausted if they live to age 95 or
older.
Table 6. Probability of Retirement Account Lasting to at Least
a Given Age, Including Mortality Risk, Retirement at Age 60
^{Initial Annual Withdra}^{wal f}^r^{om Retirement Acco}^unt^{Probability that}
^{Money Will Last}
^{at Least Until}^:^4.0%^{4.5% 5.0% 5.5%}^6.0%
^{Panel 1: Mal}^{e Retiring at Age 60, Portfolio = 65% Stocks, 3}^{5% Bonds}
^{Age 80}^{99.1 98.1}^96.4^{93.5 89.8}
^{Age 85}^{98.1 96.3}^{93.2 89.6}^84.8
^{Age 90}^{97.3 95.0}^{91.4 87.3}^82.6
^{Age 95}^97.0^{94.4 90.6}^86.4^81.9
^{Age 10}⁰^96.9^{94.3 90.5}^86.3^81.7
^{Panel 2: Mal}^{e Retiring at Age 60, Portfolio = 35% Stocks, 6}^{5% Bonds}
^{Age 80}^{99.8 99.4}^98.1^{95.1 90.8}
^{Age 85}^{99.1 97.6}^{94.1 89.1}^82.5
^{Age 90}^{98.1 95.8}^{91.4 85.6}^78.6
^{Age 95}^{97.7 95.0}^{90.4 84.3}^77.1
^{Age 10}⁰^97.5^{94.8 90.1}^84.1^76.9
^{Panel 3: F}^{emale Ret}^{iring at Age 60, Portfolio = 65% Stoc}^{ks, 35% Bonds}
^{Age 80}^{98.9 97.8}^95.5^{92.7 88.3}
^{Age 85}^{97.5 95.6}^{91.6 87.0}^81.7
^{Age 90}^96.1^{93.6 89.0}^83.7^78.3
^{Age 95}^95.5^{92.8 87.7}^82.5^77.0
^{Age 10}⁰^95.3^{92.6 87.4}^82.2^76.6
^{Panel 4: F}^{emale Ret}^{iring at Age 60, Portfolio = 35% Stoc}^{ks, 65% Bonds}
^{Age 80}^{99.7 99.2}^97.5^{94.4 88.6}
^{Age 85}^{98.4 96.7}^{92.8 86.9}^77.7
^{Age 90}^96.9^{94.3 88.2}^81.2^71.7
^{Age 95}^96.1^{92.8 86.1}^78.9^69.4
^{Age 10}⁰^95.7^{92.3 85.4}^78.4^69.0
^Source:^{Congressional Researc}^h^Service.
^Notes:^Probabil^{ities >= 95.0% a}^r^e^{in italics.}

Table 7. Probability of Retirement Account Lasting to at Least a Given Age,
Including Mortality Risk, Retirement at Age 65
^{Initial Annual Withdra}^{wal f}^r^{om Retirement Acco}^unt^{Probability that}
^{Money Will Last}
^{at Least Until}^:^{4.0% 4.5% 5.0%}^5.5%^6.0%
^{Panel 1: Mal}^{e Retiring at Age 65, Portfolio = 65% Stocks, 3}^{5% Bonds}
^{Age 80}^{99.9 99.7 99.3}^98.6^96.9
^{Age 85}^{99.3 98.4 97.3}^95.1^91.9
^{Age 90}^{98.7 97.0 95.5}^{92.6 88.5}
^{Age 95}^{98.3 96.4}^{94.8 91.6}^87.3
^{Age 10}⁰^{98.1 96.2}^{94.6 91.4}^87.1
^{Panel 2: Mal}^{e Retiring at Age 65, Portfolio = 35% Stocks, 6}^{5% Bonds}
^{Age 80}^{>99.9 >99.9 >99.9}^99.6^98.7
^{Age 85}^{99.8 99.5 98.5}^96.6^92.5
^{Age 90}^{99.3 98.2 96.2}^{92.8 87.3}
^{Age 95}^{98.9 97.4 95.0}^{91.3 85.5}
^{Age 10}⁰^{98.7 97.1}^{94.6 90.9}^85.1
^{Panel 3: F}^{emale Ret}^{iring at Age 65, Portfolio = 65% Stoc}^{ks, 35% Bonds}
^{Age 80}^{99.9 99.7 99.1}^98.2^97.0
^{Age 85}^{99.0 98.1 96.3}^{93.8 90.9}
^{Age 90}^{97.8 96.3}^{93.5 89.7}^86.0
^{Age 95}^{97.1 95.5}^{92.2 87.8}^83.9
^{Age 10}⁰^{96.9 95.1}^{91.8 87.4}^83.4
^{Panel 4: F}^{emale Ret}^{iring at Age 65, Portfolio = 35% Stoc}^{ks, 65% Bonds}
^{Age 80}^{>99.9 >99.9 99.9}^99.5^98.3
^{Age 85}^{99.9 99.2 98.1}^95.5^90.9
^{Age 90}^{99.1 97.3}^{94.3 90.1}^82.9
^{Age 95}^{98.3 95.7}^{92.1 87.3}^79.6
^{Age 10}⁰^{98.0 95.2}^{91.2 86.4}^78.8
^Source:^{Congressional Researc}^h^Service.
^Notes:^Probabil^{ities >= 95.0% a}^r^e^{in italics.}

Table 8. Probability of Retirement Account Lasting to at Least a Given Age,
Including Mortality Risk, Retirement at Age 70
^{Initial Annual Withdra}^{wal f}^r^{om Retirement Acco}^unt^{Probability that}
^{Money Will Last}
^{at Least Until Age:}^{4.0% 4.5% 5.0% 5.5% 6.0%}
^{Panel 1: Mal}^{e Retiring at Age 70, Portfolio = 65% Stocks, 3}^{5% Bonds}
^{Age 80}^{>99.9 >99.9 >99.9 99.9}^99.9
^{Age 85}^>99.9^{99.8 99.4 98.5 97.9}
^{Age 90}^{99.7 99.0 98.1 96.2}^94.5
^{Age 95}^{99.4 98.4 97.4 95.0}^92.9
^{Age 10}⁰^{99.3 98.1 97.1}^{94.7 92.6}
^{Panel 2: Mal}^{e Retiring at Age 70, Portfolio = 35% Stocks, 6}^{5% Bonds}
^{Age 80}^{>99.9 >99.9 >99.9 >99.9 >99.9}
^{Age 85}^{>99.9 >99.9 99.9}^99.6^99.0
^{Age 90}^{99.9 99.7 98.9 97.6 95.2}
^{Age 95}^{99.6 99.1 97.7 95.6}^92.4
^{Age 10}⁰^{99.5 98.8 97.2 95.1}^91.7
^{Panel 3: F}^{emale Ret}^{iring at Age 70, Portfolio = 65% Stoc}^{ks, 35% Bonds}
^{Age 80}^{>99.9 >99.9 >99.9 >99.9 99.9}
^{Age 85}^{99.9 99.7 99.4 98.6 97.7}
^{Age 90}^{99.5 98.6 97.4 95.2}^93.1
^{Age 95}^{98.8 97.6 95.9}^{93.3 90.6}
^{Age 10}⁰^{98.5 97.2 95.3}^{92.6 89.9}
^{Panel 4: F}^{emale Ret}^{iring at Age 70, Portfolio = 35% Stoc}^{ks, 65% Bonds}
^{Age 80}^{>99.9 >99.9 >99.9 >99.9 >99.9}
^{Age 85}^>99.9^{99.9 99.9 99.6 99.0}
^{Age 90}^{99.9 99.4 98.5 96.5}^93.2
^{Age 95}^{99.4 98.4 96.6}^{93.4 88.7}
^{Age 10}⁰^{99.1 97.9 95.7}^{92.3 87.6}
^Source:^{Congressional Researc}^h^Service.
^Notes:^Probabil^{ities >= 95.0% a}^r^e^{in italics.}
The estimates shown in Table 5, Table 6, Table 7, and Table 8 are based on simulations of a
withdrawal strategy that produces annual income of a constant real (inflation-adjusted) amount.
The individual takes an initial annual withdrawal equal to a particular percentage of the account
balance, and all subsequent withdrawals are equal to the real value of the initial withdrawal. In

this respect, the withdrawal strategy mimics an inflation-indexed annuity by providing a steady ⁵⁶
annual income. However, an individual who self-annuitizes must, in effect, insure against his or
her own longevity by holding substantial “reserves” in the account to protect against the
possibility of outliving his or her savings. Because insurers diversify the risk of longevity over all
annuity purchasers, they are able to pay a higher annual income than an individual who self-
annuitizes could safely withdraw from his or her account. Taking withdrawals from a retirement
account that are equal to the amount that would be paid by an annuity purchased from an ⁵⁷
insurance company exposes the retiree to the risk of outliving his assets.
If a retiree is willing to allow the amount withdrawn from the account to vary from year to year
based on investment returns and remaining life expectancy, he or she can reduce the likelihood of
fully depleting the account before dying. The trade-off for reducing this risk is that the
individual’s annual income will be less predictable. This can make planning and budgeting more
difficult. One such strategy bases each annual withdrawal on the current account balance and the ⁵⁸
individual’s remaining life expectancy. This withdrawal rule is mandated under the Internal
Revenue Code for owners of traditional IRAs and retired owners of 401(k) plans after they attain
age 70½ “to ensure that retirees consume their tax-qualified retirement pension accounts instead ⁵⁹
of leaving them as bequests for their heirs.”
Table 9, Table 10, and Table 11 show how annual withdrawals that are based on the individual’s
remaining life expectancy in the year that the withdrawal is taken can vary over the course of the
person’s retirement. Table 9 illustrates the variability of withdrawals for a man and a woman each
of whom retires at age 60 with an account balance of $100,000. Table 10 and Table 11 show
withdrawals for men and women who retire at ages 65 and 70, respectively, also with initial ⁶⁰
account balances of $100,000. In 2004, a 60 year-old man had a remaining life expectancy of ⁶¹

20.8 years and a woman had a remaining life expectancy of 24.0 years. Under the 1/E(t)

withdrawal rule, the 60 year-old man would withdraw 1/20.8 (4.8%) of his account balance and
the 60 year-old woman would withdraw 1/24.0 (4.2%) of her account. One year later, the 61 year-
old man would have a remaining life expectancy of 20.0 years and would withdraw 1/20.0 (5.0%)
of his account balance. The 61 year-old woman would have a remaining life expectancy of 23.2
years and would withdraw 1/23.2 (4.3%) of her account balance. As the retiree ages, his or her
remaining life expectancy falls, and the percentage of the account that he or she withdraws rises.
At age 75, for example, a man has a remaining life expectancy of 10.7 years and so he would
withdraw 1/10.7 (9.3%) of his remaining account balance. A 75 year-old woman has a remaining
life expectancy of 12.8 years and would withdraw 1/12.8 (7.8%) of her remaining account
balance.
⁵⁶
^{Most a}ⁿ^nu^itie^{s a}^r^e^no^{t a}^d^j^u^ste^d^f^o^{r inf}^l^a^tio^{n, a}ⁿ^d^t^h^e^inc^o^m^e^the^r^e^f^ore^de^c^line^s^{in v}^a^lue^ov^e^r^tim^e^.
⁵⁷^I^v^ic^a^D^u^s^,^R^a^im^{ond Ma}^ur^e^r^{, a}ⁿ^d^O^liv^ia^Mitc^he^{ll, “}^B^e^tti^ng^on^D^e^a^t^{h a}ⁿ^{d C}^a^pita^l^Ma^r^k^e^t^s^{in R}^e^tir^e^m^eⁿ^{t: A}^Shor^tf^a^ll
^Risk^Aⁿ^a^l^y^s^{is of}^Lⁱ^fe^A^nnuitie^s^V^e^rsus^Pha^s^e^d^W^ithdra^w^a^l^P^l^aⁿ^s,^”^Fⁱⁿ^aⁿ^cⁱ^a^l^S^e^rvi^{ces R}^evi^ew^,^vo^l^.¹⁴⁽³⁾^,⁽^F^al^{l 20}⁰⁵⁾^.
⁵⁸^Iⁿ^t^h^is^m^e^thod^of^w^ithdr^a^w^ing^f^unds^{, t}^h^e^f^r^a^c^{tion w}^ithdr^a^w^{n f}^r^om^the^a^c^c^ount^each^y^e^{ar i}^s^eq^u^a^l^t^o¹^/^E⁽^t⁾^,^w^h^{ere E}⁽^t⁾
ⁱ^s^t^h^{e p}^e^rson^{’s rem}^aⁱⁿⁱⁿ^{g years o}^f^lⁱ^f^{e exp}^ect^an^c^y^at^each^ag^e.
⁵⁹^{Dus, Ma}^ure^r^,^aⁿ^d^Mitc^he^ll^,^Fⁱⁿ^aⁿ^cⁱ^a^l^S^e^rvi^ces^R^evi^ew^{, (}²⁰⁰⁵⁾^.
⁶⁰^T^h^{e in}^{itial acco}^uⁿ^t^b^a^lan^{ce is assu}^m^e^d^to^b^e^$¹⁰⁰^,⁰⁰⁰^oⁿ^ly^f^o^{r illu}^strativ^{e p}^u^r^p^o^s^{es. W}^ith^{a sm}^allerⁱⁿ^itial^b^a^lan^ce,
^w^ithdra^w^a^l^s^w^ould^be^sm^a^lle^{r, bu}^{t the}^re^la^tiv^e^v^a^ria^b^ility^of^the^wⁱ^t^hdra^w^a^l^{s f}^r^o^m^y^e^a^r^{to y}^e^a^r^w^ould^be^sim^ila^{r. Da}^ta
^f^r^o^m^the^Ce^{nsus Bure}^a^uⁱⁿ^dⁱ^c^a^t^e^tha^t¹²^.9^m^illion^ho^use^hol^{ds he}^a^d^e^d^by^pe^rs^{ons a}^g^e^d⁶⁰^or^ol^de^{r ha}^{d a}^re^tire^m^eⁿ^t
^a^c^c^ount^of^s^o^m^e^kⁱ^{nd a}^t^y^e^a^r^-^e^nd²⁰⁰^{5, a}^nd^tha^t^4.6^m^illion^of^the^s^e^hous^e^h^ol^ds⁽³^6%^{) ha}^d^accouⁿ^t^b^a^l^aⁿ^ces^o^f
^$10^0,⁰⁰^{0 or}^m^o^r^e^.
⁶¹^“^U^nite^{d S}^t^a^t^e^s^Lⁱ^f^e^Ta^ble^s^{, 20}^04,^”^Natio^nal^Vit^a^l^Stat^istic^{s Re}^ports^,^vo^l^.⁵⁶⁽⁹⁾^,^(Decem^b^e^r²⁰⁰⁷⁾^.

Under this method, annual withdrawals are a continually rising fraction of the remaining account
balance, but the real dollar of value of the withdrawals may rise or fall from year to year,
depending on the investment performance of the retirement account. In a “worst-case scenario”
the aging retiree’s withdrawals would be a rising fraction of a shrinking account balance.
Although the retiree would not fully deplete the account—because the withdrawal is never equal
to 100% of the remaining account balance—if the account shrinks in value due to a decline in ⁶²
asset values, the withdrawals could grow smaller from year to year.
Withdrawals based on remaining life expectancy will vary in size (measured here in constant
dollars) from year to year. For example, the top panel of Table 9 shows the range of withdrawals
taken between the ages of 60 and 100 by a man who retires at age 60 with an account balance of
$100,000. Across 10,000 simulations, the typical male retiree could expect his annual
withdrawals to range from $4,465 to $9,160 with an average withdrawal of $6,394. In 5% of the
simulations, however, the smallest annual withdrawal was $1,409 or less, and in 5% of the
simulations, the largest withdrawal was $22,803 or more. A woman with the same portfolio
retiring at age 60 could expect her annual withdrawals to range from $3,940 to $9,729 with an
average withdrawal of $6,342. (See Panel 3 of Table 9. In 5% of the simulations, the smallest
annual withdrawal was $1,530 or less, and in 5% of the simulations, the largest withdrawal was
$25,968 or more.
Panels 2 and 4 of Table 9 show that when the simulations were based on a portfolio in which
65% of assets were invested in bonds and 35% invested in stocks, the average withdrawal was
smaller than in the case of the more stock-heavy portfolio. The typical male retiring at 60 with a
$100,000 portfolio invested 65% in bonds and 35% in stocks could expect his annual withdrawals
to range from $4,491 to $7,370 with an average withdrawal of $5,734. (Again, all amounts are in
constant dollars.) In 5% of all the simulations, however, the smallest annual withdrawal was
$1,100 or less, and in 5% of the simulations, the largest withdrawal was $13,184 or more. A
woman with the same portfolio who retires at age 60 could expect her annual withdrawals to
range from $3,985 to $7,465, with an average withdrawal of $5,516. (See Panel 4 of Table 9.) In
5% of all the simulations, the smallest annual withdrawal was $1,349 or less, and in 5% of the
simulations, the largest withdrawal was $14,460 or more.
For individuals who retire at age 65 or at age 70, average annual withdrawals will be higher than
for those who retire at 60 because they will be based on shorter remaining life expectancies.
Table 10 shows the estimated range of withdrawals taken between the ages of 65 and 100 by men
and women who retire at age 65 with initial account balances of $100,000. Table 11 shows the
estimated range of withdrawals taken between the ages of 70 and 100 by men and women who ⁶³
retire at age 70 with initial account balances of $100,000.
For a man retiring at age 65 with an initial account balance of $100,000 of which 65% is invested
in stocks and 35% is invested in bonds, annual withdrawals could be expected to range from
$5,284 to $9,103 with an average withdrawal of $6,861. (See Panel 1 of Table 10.) In 5% of the
⁶²
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simulations, however, the smallest annual withdrawal was $1,460 or less and in 5% of the
simulations the largest withdrawal was $19,513 or more. A woman with the same portfolio
retiring at age 65 could expect her annual withdrawals to range from $4,653 to $9,293 with an
average withdrawal of $6,582. In 5% of the simulations, the smallest annual withdrawal was
$1,554 or less, and in 5% of the simulations, the largest withdrawal was $22,126 or more.
For a man retiring at age 70 with an initial account balance of $100,000 of which 65% is invested
in stocks and 35% is invested in bonds, annual withdrawals could be expected to range from
$6,241 to $9,552 with an average withdrawal of $7,606. (See Panel 1 of Table 11.) In 5% of the
simulations, however, the smallest annual withdrawal was $1,412 or less, and in 5% of the
simulations, the largest withdrawal was $17,822 or more. A woman with the same portfolio
retiring at age 70, could expect her annual withdrawals to range from $5,504 to $9,282 with an
average withdrawal of $7,083. In 5% of the simulations, the smallest annual withdrawal was
$1,519 or less, and in 5% of the simulations, the largest withdrawal was $19,314 or more.
Table 9. Variable Annual Withdrawals Based on Life Expectancy,
Retirement at Age 60
⁽^a^c^c^{ount balance}^{at a}^g^{e 60 =}^$100,00⁰⁾
^Annual^Withdra^{wal Based o}ⁿ^{Remaining Life Expectan}^cy
⁵^th^Percenti^le^Median⁹⁵^th^P^ercentile
^{Panel 1: Mal}^{e Retiring at Age 60, Portfolio = 65% Stocks, 3}^{5% Bonds}
^{Smallest withdrawal}^1,40⁹^4,46⁵^4,81⁸
^{Mean withdrawal}^3,85⁷^6,39⁴^12,7⁸¹
^{Largest withdrawal}^4,81⁸^9,16⁰^22,8⁰³
^{Panel 2: Mal}^{e Retiring at Age 60, Portfol}^{io = 35% Stocks, 6}^{5% Bonds}
^{Smallest withdrawal}^1,10⁰^4,49¹^4,81⁸
^{Mean withdrawal}^3,97⁸^5,73⁴^8,84⁵
^{Largest withdrawal}^4,81⁸^7,37⁰^13,1⁸⁴
^{Panel 3: F}^{emale Ret}^{iring at Age 60, Portfolio = 65% Stoc}^{ks, 35% Bonds}
^{Smallest withdrawal}^1,53⁰^3,94⁰^4,16⁸
^{Mean withdrawal}^3,58⁹^6,34²^13,6³⁸
^{Largest withdrawal}^4,37⁸^9,72⁹^25,9⁶⁸
^{Panel 4: F}^{emale Ret}^{iring at Age 60, Portfolio = 35% Stoc}^{ks, 65% Bonds}
^{Smallest withdrawal}^1,34⁹^3,98⁵^4,16⁸
^{Mean withdrawal}^3,72⁹^5,51⁶^9,06¹
^{Largest withdrawal}^4,31¹^7,46⁵^14,4⁶⁰
^So^urce:^{Congressional Researc}^h^Service.

Table 10. Variable Annual Withdrawals Based on Life Expectancy,
Retirement at Age 65
⁽^a^c^c^{ount balance}^{at a}^g^{e 65 =}^$100,00⁰⁾
^Annual^Withdra^{wal Based o}ⁿ^{Remaining Life Expectan}^cy
⁵^th^Percenti^{le Median}⁹⁵^th^P^ercentile
^{Panel 1: Mal}^{e Retiring at Age 65, Portfolio = 65% Stocks, 3}^{5% Bonds}
^{Smallest withdrawal}^1,46⁰^5,28⁴^5,85¹
^{Mean withdrawal}^4,33¹^6,86¹^12,1⁴⁶
^{Largest withdrawal}^5,85¹^9,10³^19,5¹³
^{Panel 2: Mal}^{e Retiring at Age 65, Portfolio =}^{35% Stocks, 6}^{5% Bonds}
^{Smallest withdrawal}^1,14⁶^5,21⁰^5,85¹
^{Mean withdrawal}^4,44²^6,27⁰^9,02⁵
^{Largest withdrawal}^5,85¹^7,68⁹^12,5⁷²
^{Panel 3: F}^{emale retiring at Age 65, portfolio = 65% Stocks, 35% Bonds}
^{Smallest withdrawal}^1,55⁴^4,65³^5,00⁶
^{Mean withdrawal}^4,04⁴^6,58²^12,7⁶¹
^{Largest withdrawal}^5,00⁶^9,29³^22,1²⁶
^{Panel 4: F}^{emale Ret}^{iring at Age 65, Portfolio = 35% Stoc}^{ks, 65% Bonds}
^{Smallest withdrawal}^1,23³^4,64⁸^5,00⁶
^{Mean withdrawal}^4,09⁷^5,90¹^9,05⁹
^{Largest withdrawal}^5,00⁶^7,54¹^13,3⁰³
^Source:^{Congressional Researc}^h^Service.

Table 11. Variable Annual Withdrawals Based on Life Expectancy,
Retirement at Age 70
⁽^a^c^c^{ount balance}^{at a}^g^{e 70 =}^$100,00⁰⁾
^Annual^Withdra^{wal Based o}ⁿ^{Remaining Life Expectan}^cy
⁵^th^Percenti^{le Median}⁹⁵^th^P^ercentile
^{Panel 1: Mal}^{e Retiring at Age 70, Portfolio = 65% Stocks, 3}^{5% Bonds}
^{Smallest withdrawal}^1,41²^6,24¹^7,28⁵
^{Mean withdrawal}^4,93⁵^7,60⁶^12,1²⁷
^{Largest withdrawal}^7,28⁵^9,55²^17,8²²
^{Panel 2: Mal}^{e Retiring at Age 70, Portfolio = 35% Stocks, 6}^{5% Bonds}
^{Smallest withdrawal}^1,23⁰^6,17²^7,28⁵
^{Mean withdrawal}^5,02⁹^7,28⁵^9,69⁴
^{Largest withdrawal}^7,28⁵^8,51¹^12,5¹²
^{Panel 3: F}^{emale Ret}^{iring at Age 70, Portfolio = 65% Stoc}^{ks, 35% Bonds}
^{Smallest withdrawal}^1,51⁹^5,50⁴^6,16⁴
^{Mean withdrawal}^4,58⁴^7,08³^12,2³⁹
^{Largest withdrawal}^6,16⁴^9,28²^19,3¹⁴
^{Panel 4: F}^{emale Ret}^{iring at Age 70, Portfolio = 35% Stoc}^{ks, 65% Bonds}
^{Smallest withdrawal}^1,27³^5,47⁹^6,16⁴
^{Mean withdrawal}^4,66¹^6,55²^9,36⁵
^{Largest withdrawal}^6,16⁴^7,97⁸^12,7⁴¹
^Source:^Cong^{ressional Researc}^h^Service.

The uncertainties that retirees face with respect to both life expectancy and annual rates of return
on investment make choosing a withdrawal strategy for their retirement accounts one of the most
complicated financial decisions of their lives. The decision is even more complicated if retirement
assets must be managed over the joint life expectancies of a couple. In light of these complex
considerations, some analysts have suggested that “the withdrawal phase of retirement planning ⁶⁴
may well require more professional guidance and expertise than the accumulation phase.”
A retiree who wishes to achieve a predictable annual income can take annual withdrawals that are
equal in inflation-adjusted dollars. An individual who chooses a rate of withdrawal that is too
high risks spending down the account too quickly, possibly leaving the person impoverished. An
individual who chooses a rate of withdrawal that is too low risks spending down the account too
⁶⁴
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slowly, unnecessarily reducing his or her consumption and leaving substantial assets unspent at
death. On the other hand, the retiree can choose to take withdrawals that vary from year to year
based on the current balance in the account and the retiree’s remaining life expectancy. This
strategy can result in highly variable annual income.
The results of the analysis that CRS conducted indicate that under certain conditions there is a
95.0% or greater probability a man who retires at age 65 will not fully deplete his retirement
account before the earlier of his death or age 90 if his initial withdrawal does not exceed 5.0% of
the account balance and if later withdrawals are equal to the first in inflation-adjusted dollars.
Under the same conditions, there is a 95.0% or greater probability that a woman who retires at
age 65 will not fully deplete her retirement account before the earlier of her death or age 90 if her
initial withdrawal does not exceed 4.5% of the account balance and if later withdrawals are equal
to the first in inflation-adjusted dollars. The results hold for both a portfolio invested 65% in
stocks and 35% in bonds and for one invested 35% in stocks and 65% in bonds.
The weight that individuals assign to each of the risks they face in retirement will vary from
person to person. No one withdrawal strategy will be optimal for everyone. Other researchers
have noted that “overall ... there is no clearly dominant strategy, because all involve trade-offs ⁶⁵
between risk, benefit, and bequest measures, and individual preferences may vary.” One way to
balance these risks would be to segregate one’s retirement funds into two or more accounts and
adopt different withdrawal strategies for each. Likewise, one might use some retirement assets to
purchase an annuity while taking withdrawals from one or more accounts using one or more
withdrawal strategies. Many retirees, however, will not have accumulated enough retirement
savings to make these options practical.
⁶⁵
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Monte Carlo analysis is a method of estimating the probable outcome of an event in which one or
more of the variables affecting the outcome are random. The term was coined by mathematicians
in the 1940s who likened probability analysis to studying the games of chance played in the
casinos of Monte Carlo. One common use of Monte Carlo simulations is to illustrate how the
variability of investment rates of return can affect the balances in a retirement account. The
essence of a Monte Carlo estimation process is to simulate an event many times, allowing the
random variable to vary according to its mathematical mean and variance. Each outcome is then
ranked according to the likelihood of its occurrence. Using Monte Carlo methods, analysts can
estimate not just the result that will occur “on average,” but also the likelihood of results that are
significantly above or below the average. In other words, Monte Carlo methods of estimation
allow us to incorporate into our estimates the element of risk.
Monte Carlo estimation methods utilize not just the average value of a random variable, but also
the distribution of values around the average. For example, rates of return in the stock market
vary from year to year. The nominal rate of return on the Standard & Poor’s 500 index of stocks
averaged 10.3% between 1926 and 2007, but annual rates of return varied widely around this
average, producing a standard deviation of 20.0%. Likewise, while the nominal annual return on
AAA-rated corporate bonds averaged 6.3% between 1926 and 2007, the standard deviation
around this average was 7.0%.
To estimate the likely rate of return that an investment would achieve over a 40-year period, for
example, Monte Carlo simulation software generates a rate of return for each year based on the
distribution of probable rates of return, as derived from historical data. The program then
simulates the 40-year period a second time, again generating a rate of return for each year from
the probability distribution of rates of return. The process is repeated until the simulation is
completed, and thousands of 40-year investment periods have been simulated. The results of the
simulation—in this case, investment rates of return—are then ranked by percentiles. The model
CRS used also accounted for the correlation between the rates of return on stocks and bonds and
the effects of inflation on real annual returns.
In our simulation of a 40-year period in which 100% percent of assets were invested in common
stocks, the mean real rate of return in 10,000 iterations (simulating a 40-year period 10,000 times)
was 7.0%, which is the same as the actual mean real rate of return on common stocks in the
period from 1926 through 2007. (1.103/1.0305 = 1.70) However, in 5% of those 10,000 iterations,
the mean real rate of return over the 40-year period was 1.6% or less, while at the other extreme,
in 5% of the 10,000 iterations, the mean real rate of return over the 40-year period was 12.4% or
more. In terms of evaluating risk, these results imply an expected annual average real rate of
return on common stocks over any given 40-year period of 7.0%, and a 90% probability that the
average annual real rate of return over that period will be between 1.6% and 12.4%.

Table B-1. Life Expectancy at Each Age, in Years
^{Age Men}^Women
^{60 20.8}^24.0
^{61 20.0}^23.2
^{62 19.3}^22.4
^{63 18.5}^21.6
^{64 17.8}^20.8
^{65 17.1}^20.0
^{66 16.4}^19.2
^{67 15.7}^18.4
^{68 15.0}^17.7
^{69 14.4}^16.9
^{70 13.7}^16.2
^{71 13.1}^15.5
^{72 12.5}^14.8
^{73 11.9}^14.1
^{74 11.3}^13.5
^{75 10.7}^12.8
^{76 10.2}^12.2
^{77 9.6}^11.5
^{78 9.1}^10.9
^{79 8.6}^10.3
^{80 8.2}^9.8
^{81 7.7}^9.2
^{82 7.3}^8.7
^{83 6.9}^8.2
^{84 6.5}^7.7
^{85 6.1}^7.2
^{86 5.7}^6.8
^{87 5.4}^6.3
^{88 5.0}^5.9
^{89 4.7}^5.6
^{90 4.4}^5.2
^{91 4.2}^4.9
^{92 3.9}^4.5
^{93 3.7}^4.2

^{Age Men}^Women
^{94 3.4}^3.9
^{95 3.2}^3.7
^{96 3.0}^3.4
^{97 2.8}^3.2
^{98 2.6}^3.0
^{99 2.5}^2.8
¹⁰⁰^{+ 2.3}^2.6
^Source:^{U.S. Department of H}^e^{alth and Hu}^{man Services,}^National
^{Center for}^{Health Statistics,}^{National Vital Statistics Reports}^{, vol. 56, no.}
^{9, December}^28,²⁰^{07, Tables 2}^{and 3.}

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