R. Gregory Barton P.O. Box 2900 

Managing Director Valley Forge, PA 19482

Institutional Investor Group 610-669-1000

www.vanguard.com

Submitted Electronically

May 3, 2010 

Office of Regulations and Interpretations

Employee Benefits Security Administration 

Room N-5655

U.S. Department of Labor

200 Constitution Ave, NW

Washington, DC 20210

Attention: Lifetime Income RFI (RIN 1210-AB33)

Dear Sir or Madam:

In the marketplace today, there is growing interest in programs that can help retirement 

plan participants translate a pool of savings into a regular income stream. Lump sum 

benefit payments are the norm in defined contribution (DC) plans, and these payouts are 

expected to increase in value in the future. Many defined benefit (DB) plans, especially 

cash balance plans, offer a lump sum option. Plan sponsors, providers and regulators are 

concerned about the ability of some participants to manage these assets successfully. 

Participants are also seeking to ensure that their savings last throughout retirement, and 

are looking for convenient ways to generate a regular income from their savings. 

The Administration is to be congratulated for highlighting this important issue and 

focusing regulatory attention on the matter. Based on Vanguard’s extensive experience

serving the needs of plan sponsors and participants, we believe investors’ diverse needs 

in retirement will be best served by allowing them to choose from an array of guaranteed 

and non-guaranteed payout options. Policymakers should not skew individual household 

decisions unduly toward annuities through tax incentives or mandates. 

Vanguard is one of the world’s leading asset managers, managing $1.4 trillion in assets 

for institutional and retail investors. We are a leading investment manager and 

administrator for DC and DB plans and Individual Retirement Accounts (IRAs). 

Specifically, we manage nearly $400 billion in DC and DB plan assets; provide 

recordkeeping services for more than 3.5 million plan participants in 2,500 DC plans and 

for approximately 550,000 participants in 100 DB plans; and provide investment and 

account services for 2.5 million IRA holders.
 

Office of Regulations and Interpretations Page 2

Employee Benefits Security Administration 

At Vanguard we offer a number of retirement income solutions for participants and other 

investors, largely as “outside the plan” options for Individual Retirement Account (IRA) 

rollovers and after-tax savings. These income options include: (1) dividend distributions

from mutual funds; (2) systematic withdrawal plans; (3) required minimum distributions

from tax-deferred accounts; (4) payout funds, which provide a regular stream of income 

from a portfolio; and (5) deferred and immediate annuities. 

Retirement income overview

As in the accumulation phase of saving, participants in the retirement income phase must 

strike a balance among risk, return, and cost. They need to weigh competing objectives 

for their assets, which include regular income, spending flexibility, liquidity, survivor 

needs and bequests. At the same time, they need to consider a range of risks, including 

the unique risk of the spend-down phase—longevity risk—along with the explicit or 

implicit costs of a particular drawdown strategy. 

We define “lifetime income” broadly, meaning the concept should include both 

guaranteed and non-guaranteed sources of income. Moreover, we expect that 

nonguaranteed strategies such as withdrawals from a retirement account, rather than 

guaranteed income annuities, will be the dominant strategy used by plan participants in 

the drawdown phase. This is current practice among households with tax-deferred 

accounts, and we believe it will continue into the future. 

Traditional income annuities are likely to play only a limited or secondary role for most 

retirees for a variety of reasons. Most households already expect to receive a meaningful 

level of guaranteed income from Social Security in retirement, muting investor demand 

for private annuities. Also, while annuities offer a valuable guarantee against longevity 

and investment risk, they also impose substantial restrictions in terms of the loss of 

liquidity (loss of access to savings) and the loss of flexibility in spending. In addition, 

some annuity contracts are expensive and lack fee transparency. Finally, all annuity 

guarantees are subject to the credit or solvency risk of the issuer. As an investment 

manager, Vanguard has extensive experience evaluating the credit risk of insurers. This 

analysis requires a high degree of sophistication and needs to go beyond a review of 

credit ratings to be effective. This degree of analysis would be challenging for many 

employers, and virtually impossible for individual investors who are being asked to 

evaluate the credit worthiness of an insurer who could be paying them benefits for 20 to 

30 years. 

We also anticipate that participants will make most retirement income decisions in the 

context of an IRA rollover account, outside the confines of their employer’s qualified 

retirement plan. Some plan sponsors have expressed interest in offering retirement 

income solutions inside qualified plans. However, many more plan sponsors have 

reservations about in-plan solutions. They are concerned about fiduciary responsibility 

for selecting and monitoring in-plan retirement income solutions, worried that few 
 

Office of Regulations and Interpretations Page 3

Employee Benefits Security Administration 

participants will actually use the products, and feel that the products themselves are new 

and present administrative challenges. We do not think the reluctance of employers to 

adopt in-plan solutions is a problem. Most Vanguard participants at retirement age leave 

their employer-sponsored DC plan within three years. Thus, retirement income solutions 

designed for IRA rollovers are likely to assist the greatest number of retirees. 

Finally, the retirement income marketplace today is characterized by a high level of 

innovation. Investment companies, insurers and other providers are developing a range 

of strategies offering participants either non-guaranteed or guaranteed income streams. 

We foresee this innovation continuing for the foreseeable future. 

Given the nature of participant demand, as well as rapid innovation in the marketplace, 

we would question any policy rationale that encourages one type of retirement income 

product, such as the traditional income annuity, over any other strategy, such as a 

portfolio withdrawal program. Rather, the policy goal should be to ensure a level playing 

field among competing strategies, and to encourage the provision of adequate information 

to plan participants about the benefits, risks and costs of different approaches. The aim 

of policymakers should be to help participants make better choices, allowing them to 

benefit not only from traditional income products but also newer innovations emerging in 

the marketplace. 

We again thank the Administration for its interest in this critical topic facing plan 

sponsors and plan participants. Our detailed responses to the individual questions in the 

RFI and copies of some research we’ve conducted on the topic are attached. 

* * *

Vanguard appreciates the opportunity to submit these comments and we would 

welcome the opportunity to continue working with the Department if we can be of 

additional assistance. If there are any aspects of our comments that you would like 

to explore in greater detail, please do not hesitate to contact me or Ann Combs at 

610-503-6305.

Sincerely yours,

R. Gregory Barton

Attachments 
Responses to Request for Information Questions: (RIN 1210-AB33) 

- 1 - 

1. From the standpoint of plan participants, what are the advantages and 

disadvantages for participants of receiving some or all of their benefits in the form 

of lifetime payments?

Programs that generate regular income from lump-sum savings can be beneficial in 

several ways. They can help participants liquidate their assets in an orderly fashion, 

minimizing or eliminating the risk of premature depletion of savings in retirement, the socalled longevity risk. They can also be a convenient tool for participants seeking an 

income stream from a pool of savings.1 

Broad definition of retirement income. We are pleased to see the Departments use the 

term “lifetime payments” to describe their policy objective as opposed to the more 

limited term “annuity payments.” This is a critical distinction in that retirement income 

strategies appropriately include non-guaranteed or portfolio-based strategies, as well as 

annuity-based programs. 

We believe that, as is current practice, most retirement income decisions will continue to

be based on nonguaranteed or portfolio-based solutions, rather than annuity contracts. 

These portfolio strategies include spending portfolio income or taking periodic 

withdrawals from an account or a portfolio. A systematic withdrawal approach can be 

established by a participant on his or her own, or with the help of a financial planner. In a 

new category of mutual funds known as payout funds, the withdrawal program is 

structured by the investment adviser of the fund. (See Question 6.) 

For most participants, guaranteed income also has a critical role to play. However, a 

meaningful level of guaranteed income is already provided by Social Security. We 

therefore expect that traditional income annuities, while important, will play only a 

limited role in generating retirement income for a subset of participants. 

Traditional annuities do offer a valuable guarantee against longevity and investment risk. 

Yet there are costs and risks to annuitization that are often ignored in simple economic 

models of investor decision-making. Specifically, traditional annuities are costly in terms 

of the loss of liquidity (loss of access to savings) and the loss of flexibility in spending. 

Annuity contracts may be expensive and may lack fee transparency. All annuity 

guarantees are subject to the credit or solvency risk of the issuer. As noted, the demand 

for private annuities is reduced by the presence of Social Security. (See also Question 2.) 

 

1

 For a review of retirement income research, including strategies, products and household behavior, see the 

following. (1) John Ameriks and Olivia S. Mitchell. Recalibrating Retirement Spending and Saving. 

Oxford University Press, 2008. (2) Gary R. Mottola and Stephen P. Utkus. “Spending the Nest Egg.” 

Vanguard Center for Retirement Research, October 2008. https://institutional.vanguard.com/VGApp/iip/ 

site/institutional/researchcommentary/ article?File=RetResSpendingDownSavings. (3) Gary R. Mottola 

and Stephen P. Utkus. “The Retirement Income Landscape.” Vanguard Center for Retirement Research, 

December 2008. https://institutional.vanguard.com/VGApp/iip/site/institutional/ researchcommentary/ 

article?File=RetResRetireStrat.
Responses to Request for Information Questions: (RIN 1210-AB33) 

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Participants place a substantial value on both liquidity and flexibility in retirement. 

These concerns arise because of a general uncertainty over how long retirement may last, 

as well as worries over unpredictable spending such as health care costs. While worried 

about future uncertainties, most participants want to retain access to their savings—they 

want to know their funds are immediately available if needed, even though the likelihood 

of immediately needing them is modest. Some participants also have a strong desire to 

make bequests. Most Americans with retirement savings remain interested in taking 

measured investment risks with their assets, even when retired. Thus, we believe that 

most participants will seek out non-guaranteed income solutions that emphasize liquidity 

and flexibility. 

For individual investors, the main challenge appears to be how to create a personalized 

retirement income plan from both traditional and newer income options. Such a plan 

would integrate nonguaranteed and guaranteed elements and be tailored to an individual’s 

preferences for return, risk, and cost.

Beyond-the-plan solutions. Today, participant retirement income decisions occur within 

the confines of Individual Retirement Account (IRA) rollover accounts and after-tax 

savings, and generally not within qualified defined contribution plans. At Vanguard, 

more than 80% of participants age 60 and older exit their employer qualified plan within 

three years of termination of employment. More than 80% of assets exit the plan as well, 

with the vast majority of assets rolling over to an IRA. Although there is likely to be 

some residual in-plan demand for retirement income programs, we believe that this trend 

toward most income decisions being made “beyond the plan” will persist for the 

foreseeable future.

Rapid innovation in marketplace (see Questions 4, 5, 6 and 7). The current marketplace 

for retirement income is one characterized by rapid innovation on the part of both 

insurers and investment companies. We anticipate that such innovation will continue in 

the coming years. Policymakers should seek to ensure that any rule-making does not 

impede marketplace innovation by a premature endorsement or mandate to follow a 

specific type of retirement income strategy or product. 

Role of mandates (see Question 13). We question any policy rationale that favors one 

specific category of retirement income program, such as the traditional annuity contract, 

over any other. Although longevity risk is a policy concern, most participant households 

receive a meaningful level of longevity risk protection through Social Security. There 

also is no widely accepted view of the minimum amount of annuity income participants 

should have in retirement. Moreover, lower-wage workers, who may be perceived as 

being at greatest risk, have higher replacement rates from Social Security and lower asset 

levels; rather than needing more annuitized income, they may wish to maintain control 

over any liquid assets they own. Finally, as noted above, the marketplace is characterized 

by rapid innovation, and the product landscape is dynamic. From a policy perspective, it 

is premature to determine that a particular insurance or investment product is broadly 

applicable to most plan participants. 
Responses to Request for Information Questions: (RIN 1210-AB33) 

- 3 - 

Role of defaults (see Question 11). A change in plan defaults, which has proven so 

successful in the accumulation phase, is unlikely to have much impact on the demand for 

annuity income. Our research suggests that older participants are more likely to be active

decision-makers and more willing to override annuity defaults.2 However, additional 

research in this area may be useful. 

Choice, education and advice (see Question 18). In this rapidly evolving landscape, with 

wide variation in participant needs for flexibility, liquidity and guarantees, we do not 

foresee that a single retirement income product or strategy will meet the needs of most or 

all participants. Participants and plan sponsors need the flexibility to choose from an 

array of investment and insurance products in the marketplace. 

Many offerings in the marketplace are complex, and it can be challenging for participants 

to evaluate competing retirement income strategies. Thus, it should be a top policy 

priority to encourage sponsors to provide education and advice to participants on 

retirement income decisions, whether portfolio- or annuity-based. Sponsors in particular 

are seeking clarification about rules regarding retirement income education. We believe 

that existing Department of Labor guidance on education should be expanded to 

explicitly incorporate the spend-down phase of retirement. In this regard, it is very 

important that the Department’s forthcoming final advice rules be flexible enough to 

allow for responsible, cost-effective advice programs, since these rules will be applicable 

in both accumulation and spend-down phases.

In the end, plan sponsors view plan education and advice as critical to their ability to help 

participants spend down their savings wisely, and to benefit from traditional retirement 

income products as well as the latest innovations.

2. Currently the vast majority of individuals who have the option of receiving a 

lump sum distribution or ad hoc periodic payments from their retirement plan or 

IRA choose to do so and do not select a lifetime income option. What explains the

low usage rate of lifetime income arrangements? Is it the result of a market failure 

or other factors (e.g., cost, complexity of products, adverse selection, poor decisionmaking by consumers, desire for flexibility to respond to unexpected financial 

needs, counterparty risk of seller insolvency, etc.)? Are there steps that the Agencies 

could or should take to overcome at least some of the concerns that keep plan

participants from requesting or electing lifetime income?

The best-known form of lifetime income arrangement is the single-premium immediate 

annuity (SPIA), where in exchange for a lump-sum investment an individual receives a 

 

2

 Gary R. Mottola and Stephen P. Utkus. “Lump Sum or Annuity? An Analysis of Choice in DB Pension 

Payouts.” Vanguard Center for Retirement Research, November 2007. https://institutional.vanguard.com/ 

iip/pdf/CRRLSA.pdf. 
Responses to Request for Information Questions: (RIN 1210-AB33) 

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fixed, guaranteed income stream, typically for life.3 Use of such contracts is generally 

quite low. For example, among older investors in Vanguard IRAs, only 1% or so have 

obtained quotations on Vanguard’s low-cost immediate single-premium annuity. 

We do not believe that a single reason explains low rates of annuitization; rather, the 

modest take-up rates are due to a combination of factors. First, many households may 

view Social Security benefits—a low-cost, government-guaranteed annuity—as all of the 

annuity income they need. In effect, Social Security benefits may suppress consumer 

demand for private annuities. Second, traditional annuity contracts impose costs with 

respect to liquidity (participants lose access to their savings in exchange for a monthly 

income) as well as inflexibility of the income stream (participants cannot vary their 

income stream in response to unpredictable or varying needs). Because annuities are so 

complex and the decision to purchase is essentially irrevocable (unless the investor is 

willing to pay a substantial penalty), the conventional wisdom is that annuities are “sold 

rather than bought”. 

Third, many participants are uncomfortable risking a large portion of their savings with a 

single insurer. Although insurers are regulated as to solvency and soundness, the 

variability and complexity of the 50-state guaranty system (including what insurers are 

permitted to communicate, the level of the actual guarantee, the timeliness of payments 

pending resolution of the insurer, and the financial backing of the guaranty system) are 

confusing and frustrating to investors. Vanguard has extensive experience analyzing the 

credit-worthiness of insurance companies and we would never rely solely on industry 

ratings to do our due diligence. Individuals wishing to guarantee a significant amount of 

their retirement savings, should look behind the ratings and consider diversifying their 

investment among multiple carriers.

Fourth, there are a range of other considerations that further discourage annuity usage. 

These include the fact that many individuals have a desire to leave a bequest for future 

generations or charities; many individuals with meaningful assets are also more likely to 

be covered by existing DB plans and so have no need for additional annuity income; and 

many older households are married couples and so risk-sharing occurs across the 

household and across generations.

A related problem in the annuity market is consumer confusion between fixed and 

variable annuities. Variable annuities are an insurance contract whose performance is 

tied to the investment results of a portfolio. Variable annuities can provide lifetime 

income (although at Vanguard, only 1% of our variable annuity investors have chosen a 

retirement income option). Within the insurance industry, a new generation of variable 

annuities, with “living benefit” riders, are designed with the goal of providing retirement 

income and investment performance; they seek to provide guaranteed income, flexible 

access to savings and underlying growth of assets. However, such programs have high 

 

3

 John Ameriks and Liqian Ren. “Generating Guaranteed Income: Understanding Income Annuities.” 

Vanguard Investment Counseling & Research. https://personal.vanguard.com/us/ 

literature/learnaboutinvesting/ investmentguides. 
Responses to Request for Information Questions: (RIN 1210-AB33) 

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fees relating to their guarantees.

4

 Finally, some variable annuity programs have been 

associated with unethical or illegal sales techniques and have been subject to enhanced 

scrutiny by regulators. The complexity associated with the variable annuity category 

may spill over to fixed annuities, leading to investor confusion and uncertainty. 

For these reasons, we envision that, as is current practice, most retirement income 

decisions will be based on nonguaranteed or portfolio-based solutions, rather than annuity 

contracts. Also, as noted in Questions 1 and 13, we do not support regulatory action that 

favors annuities over other retirement income approaches. 

3. What types of lifetime income are currently available to participants directly 

from plans (in-plan options), such as payments from trust assets held under a 

defined benefit plan and annuity payments from insurance contracts held under a 

defined contribution or defined benefit plan?

Defined contribution plans. Vanguard serves as recordkeeper for over 2,500 DC plans 

with more than 3.5 million participants. Less than 10% of Vanguard DC plans are money 

purchase pension plans, which by law include a qualified joint and survivor annuity 

(QJSA) distribution option. We do not regularly track participant adoption of in-plan 

annuity contracts but we estimate it to be negligible. With the change in tax qualification 

rules under EGTRRA, many sponsors have shifted away from money purchase plans, and 

toward profit-sharing plans, in part in order to avoid the complexity of administering a 

statutory QJSA feature. (See also Question 25.)

Of the remaining 90% of DC plans at Vanguard, most are profit-sharing plans with a 

401(k) or 403(b) elective deferral feature. Virtually none of these plans offers an in-plan 

annuity option.

Sponsors have expressed a number of reasons why they choose not to offer in-plan 

annuity options for DC plans:

· Fiduciary oversight. The fiduciary decision to select an insurer can be complex

and adds to a sponsor’s risk exposure. Many plan sponsors find it difficult to 

assess the credit-worthiness of insurers; it is generally unfamiliar territory for 

most ERISA committees. This is particularly challenging for smaller employers 

who may lack the expertise. At a minimum, committees may find it necessary to 

incur the added cost of retaining an outside expert to assist with the selection and 

monitoring of an insurance provider. Product fees are also often difficult to 

discern and evaluate. 

· Comparability. Contracts from different competitors are difficult to compare; 

terms and conditions, as well as fee structures and guarantees, differ. Moreover,

it is hard to find long-term data on annuity pricing necessary to make informed 

choices. (A new innovation known as an “annuity mart” has emerged to provide 

 

4

 Participants in qualified plans should not pay additional fees for the tax advantages associated with 

variable annuities although additional fees are appropriate to pay for the guaranteed income feature.
Responses to Request for Information Questions: (RIN 1210-AB33) 

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comparability among annuity contracts. But annuity marts currently are offered 

as an outside-the-plan solution, primarily because of ERISA fiduciary concerns.) 

· Long-term risk. Under current DOL regulations, fiduciaries are responsible for 

ensuring that a given insurer is a prudent option at the time a contract is issued to 

participants. Yet given the irrevocability and long-lived nature of annuity 

contracts, some employers worry about a residual responsibility for the selection 

of an insurer over time.

· Low participant usage. Sponsors note that participant demand is low when 

annuities are offered in other settings. Thus, few feel compelled to offer a 

distribution option that will increase administrative costs for all participants and

that is unlikely to be widely used.

Defined benefit plans. Vanguard serves as a recordkeeper for over 200 DB plans with 

approximately 500,000 participants. By law, these plans are required to provide a normal 

form of benefit that is a qualified joint and survivor annuity (or qualified optional 

survivor annuity) for married participants and a single life annuity for unmarried 

participants. Most offer a variety of other optional forms of annuities. When an annuity 

is selected by a participant, the benefit is typically provided either by periodic payments 

directly from the plan to the participant, or through the purchase of a single premium 

immediate annuity from an insurance company. A fraction of the traditional annuity 

plans, as well as most hybrid plans like cash balance plans, offer a lump-sum option. 

4. To what extent are the lifetime income options referenced in question 3 provided 

at retirement or other termination of employment as opposed to being offered 

incrementally during the accumulation phase, as contributions are made? How are 

such incremental or accumulating annuity arrangements structured?

None of the DC plans for which Vanguard serves as recordkeeper currently offer a 

deferred annuity option, where lifetime annuity income is purchased gradually with each 

contribution. DC money purchase plans at Vanguard provide immediate annuity payout 

options only at retirement or other termination of employment. 

Sponsors have expressed a number of reservations about deferred annuity contracts.5 

One concern is the fiduciary oversight of such contracts. As noted in Question 3, 

sponsors find evaluation of creditworthiness challenging, and it is difficult for sponsors to 

compare pricing of deferred annuities on an apples-to-apples basis among providers. 

In addition, deferred annuity contracts pose additional issues: 

· Liquidity of contract. Once a deferred annuity contract is added to a plan, it 

typically remains in the plan for the foreseeable future. If a sponsor switches to a 

 

5

 For related comments on deferred annuity contracts, see: William J. Burns and Stephen P. Utkus. “”DB 

in DC’: Deferred Annuities in Defined Contribution Plans.” Vanguard Center for Retirement Research, 

May 2008. https://institutional.vanguard.com/VGApp/iip/site/institutional/researchcommentary/

article?File=ResNoteDeferredAnnuities.
Responses to Request for Information Questions: (RIN 1210-AB33) 

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new insurer, the monies invested in the old contract must typically remain in that 

contract in order to maintain the guarantee provided by the prior insurer. 

Sponsors remain concerned about residual fiduciary liability as well as ongoing 

complexity of administering the plan. 

· Portability. Deferred annuities have unique recordkeeping requirements and so 

may not be readily moved from one recordkeeper to another. Because the market 

penetration of these products is still negligible, a participant who changes jobs 

will likely not be able to transfer the guarantee to her new employer. However, 

there is an industry effort to standardize these types of recordkeeper-torecordkeeper transfers. 

· Higher fees upon rollover. If participants do take a rollover from a deferred 

annuity plan option to its retail equivalent in order to preserve the guarantee, they 

likely face higher fees. 

· Participant guarantee costs. Participants incur additional costs for the guarantee 

while accumulating assets in these contracts. Yet because most participants are 

likely to take a lump sum, either at retirement or upon job change, there is a 

concern that participants could pay for a guarantee and then fail to take advantage 

of the benefit.

5. To what extent are 401(k) and other defined contribution plan sponsors using 

employer matching contributions or employer nonelective contributions to fund 

lifetime income? To what extent are participants offered a choice regarding such use 

of employer contributions, including by default or otherwise?

None of the DC plans for which Vanguard serves as recordkeeper currently invests 

employer contributions in a deferred annuity option. Sponsors have expressed a number 

of concerns about deferred annuity contracts generally, as discussed in Questions 3 and 4. 

 

6. What types of lifetime income or other arrangements designed to provide a 

stream of income after retirement are available to individuals who have already 

received distributions from their plans (out-of-plan options), such as IRA products, 

and how are such arrangements being structured (fixed, inflation adjusted, or other 

variable, immediate or deferred, etc.)? Are there annuity products under which 

plan accumulations can be rolled over to an individual retirement annuity of the 

same issuer to retain the annuity purchase rights that were available under the

plan? 

At Vanguard we offer both portfolio-based or nonguaranteed income options, as well as 

guaranteed annuity options, for participants “outside the plan.” These include:

1. Taxable account distributions. An investor with taxable (non-qualified) assets 

may elect to have regular dividend (income) distributions paid in cash. 

2. Systematic withdrawal plans. An investor may establish a program that 

automatically withdraws a dollar or percentage amount on a monthly, quarterly or 
Responses to Request for Information Questions: (RIN 1210-AB33) 

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annual basis from a taxable or tax-deferred account. Participants may establish 

this plan on their own, or work with a certified financial planner to discuss 

withdrawal strategies and amounts. 

3. Required minimum distributions. Investors may elect to receive required 

minimum distribution (RMD) payouts required after age 701⁄2 from IRAs. In both 

retail IRA accounts and qualified DC plans, Vanguard can calculate the amount, 

advise the participant, and transfer actual dollar amounts.

4. Managed Payout Funds. Vanguard Managed Payout Funds combine an 

investment portfolio along with a distribution or payout strategy. Our approach is 

similar to that used by the endowments of colleges and universities, who invest a 

portfolio in an effort to preserve or build capital while generating a regular 

income stream. Vanguard offer three funds with distinct objectives for investors 

with varying needs for income and growth. Like all mutual funds, the funds are 

not guaranteed and are subject to various risks. They also provide daily liquidity. 

5. Income annuities. Our annuity program, known as Vanguard Lifetime Income 

Program (VLIP), offers fixed and inflation-adjusted immediate income annuities. 

We also offer a deferred fixed and variable annuity contracts; these are largely designed 

for accumulation rather than retirement income purposes. 

7. What product features have a significant impact on the cost of providing lifetime 

income or other arrangements designed to provide a stream of income after 

retirement, such as features that provide participants with the option of lifetime 

payments, while retaining the flexibility to accelerate distributions if needed?

In recent years, responding to concerns about loss of liquidity and flexibility in traditional 

annuity contracts, insurers have created new “living benefits” variable annuities offering 

flexible withdrawals and liquid access to savings. These new arrangements vary from 

provider to provider. Generally, they pay a guaranteed income for life, typically at a rate 

(such as 4-5% of the amount invested) that is lower than that available from a traditional 

annuity (6-7%). The investor’s account balance is invested in a diversified portfolio, and 

may rise and fall in value over time. Growth in the underlying account can often lead to 

a “step up” in guaranteed income. An important feature is that the investor has access to 

the underlying account value (subject to withdrawal restrictions and penalties) and so has 

access to liquid savings. When savings are withdrawn, however, the guaranteed income 

amount is reduced on a pro rata basis.

These types of instruments show promise in blending investment and insurance contract 

features that will be attractive to some participants. However, a number of concerns have 

arisen about the first generation of these products:

· Complexity and lack of transparency. Many of these arrangements are quite 

complex, and it is difficult for most participants or plan sponsors to evaluate the 

nature of the guarantees, especially without sophisticated financial advice. 
Responses to Request for Information Questions: (RIN 1210-AB33) 

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· Hedging stock market risk. Successful management of these products requires 

skill at hedging stock market risks. Yet it is an open question whether insurers 

can effectively hedge such risk without substantial risks to solvency. During the 

2008-2009 financial crisis, many insurers reported losses arising from “living 

benefit” contracts and had to reduce the value of promised guarantees and 

increase fees. As the products grow in scope and size, a similar financial-system 

crisis in the future could threaten the solvency of some insurers if the risks of 

these contracts are mismanaged. Separate from this long-term risk, state 

regulatory rules limit how quickly insurers can revise pricing to accommodate 

dynamic changes in the markets for hedging these risks. 

· High fees. Many of these products come with substantial guarantee fees, such as 

1.5% to 2%. Such fees are probably a reasonable estimate of what it costs to 

provide guaranteed income over normal market cycles. Investment and 

administrative fees come on top to these amounts. Such fees substantially reduce 

future growth on the underlying account, and so may make the guarantee too 

costly for many participants. Also, high fees mean that the expected “step up” or 

growth in income or account balance may be less than anticipated. 

From a plan sponsor perspective, evaluating such contracts, and determining whether 

they will generate value for participants, is an important fiduciary challenge. 

Some providers have begun offering living benefits annuities as part of deferred annuity 

contracts within qualified plans. For example, a target-date fund designed for 

accumulating savings may include a guarantee feature; at retirement, the participant has 

the option of annuitizing the balance (and losing all access to savings) or receiving a 

“living benefit” annuity payout (and retaining liquidity and market risk). The guarantee 

feature, which raises the participant’s cost during the accumulation phase, ensures that at 

retirement some minimum guaranteed amount will be converted to income, regardless of 

market fluctuations. 

Some “living benefits” contracts have low guarantee fees, typically under 1%. (There are 

investment fees in addition to the guarantee fee.) Such low guarantee costs are probably 

based on the notion that most participants who purchase the contracts in the accumulation 

phase will not take advantage of the guaranteed income upon retirement. Otherwise, the 

guarantee costs would be higher. These types of contracts raise the same concern noted 

above (see Question 4) about deferred annuity contracts in general: many participants 

may pay for a guarantee that they are unlikely to use, either because they eventually 

change employers, or at retirement they choose a rollover and not an annuity payout.

 

8. What are the advantages and disadvantages for participants of selecting lifetime 

income payments through a plan (in-plan option) as opposed to outside a plan (e.g., 

after a distribution or rollover)? 

There are two major differences between in-plan and outside-the-plan options: flexibility 

and pricing. 
Responses to Request for Information Questions: (RIN 1210-AB33) 

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In terms of flexibility, participants will find a wider array of retirement income programs, 

from a large number of financial institutions, available outside the plan rather than inside 

the plan. For example, at Vanguard participants have access to several strategies in our 

IRA rollover program (systematic withdrawals, RMD withdrawals, payout funds, and 

annuities). Qualified plans at Vanguard offer a limited suite of options (typically 

systematic and RMD withdrawals) because of fiduciary and administrative issues 

outlined earlier. The flexibility issue is exacerbated by employer plan design decisions. 

Some plans do not permit annuities, partial withdrawals or installment payouts; thus, the 

participant has no option other than to take a lump-sum distribution or to roll over to an 

Individual Retirement Account or annuity outside of the plan. 

A second consideration is pricing, particularly for participants in large plans. In a large 

plan, the sponsor is typically able to negotiate lower fees than would be available to a 

small plan or a retail investor. For example, today large plans can offer low-cost 

institutional mutual funds or commingled funds as investment options. Thus, at least in 

theory, they might be able to negotiate low-priced retirement income solutions for their 

plans. However, the market for in-plan retirement income solutions is relatively 

underdeveloped; today there is not yet a well-defined set of low-cost, institutionally 

priced within-plan income products. 

Despite differences in fees, we anticipate that most retirement income decisions will 

continue to be made in the IRA rollover marketplace, not in qualified plans. As noted in 

Question 1, at Vanguard over 80% of participants age 60 and older exit their employer 

qualified plan within three years of termination of employment. Over 80% of assets exit 

the plan as well, with the vast majority of the assets rolling over into IRA accounts. 

Although more research is needed on the subject, we believe that most participants leave 

their employer plan because they have terminated their relationship with their employer, 

and would like to manage their savings independent of that prior employment 

relationship and in coordination with other assets and income. 

9. What are the advantages and disadvantages from the standpoint of the plan 

sponsor of providing an in-plan option for lifetime income as opposed to leaving to 

participants the task of securing a lifetime income vehicle after receiving a plan 

distribution?

When considering adding in-plan options, sponsors typically weigh the added fiduciary 

oversight and risk against the expected benefit to be realized by participants. The 

fiduciary decision to select an insurer or provider can be complex and adds to a sponsor’s 

risk exposure. Many plan sponsors find it difficult to assess the credit-worthiness of 

insurers; it is generally unfamiliar territory for most ERISA committees. Fees are often 

difficult to discern as well. Meanwhile, participant take-up is generally expected to be 

low. It is true that some sponsors may feel the desire to take action and have an in-plan

retirement income option, regardless of its take-up. But in our experience most sponsors 
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remained concerned about the fiduciary risks and the ultimate lack of demand. (Please 

see also Questions 3 and 4.) 

More broadly, from a general employee relations perspective, many sponsors see their 

role as providing access to a well-designed retirement plan, contributing to their 

employees’ retirement savings, and acting as a prudent steward of the plan on their 

employees’ behalf. They see the qualified plan as a tool to attract and retain their current 

workforce, not to maintain long-term relationships with departed employees. From a 

benefits design perspective, they also may worry about the severe penalty (plan 

disqualification) associated with any errors in providing required minimum distribution 

payments after age 701⁄2. These plan sponsors may want to educate their employees about 

appropriate retirement income solutions outside the plan, but they would prefer not to 

have retirees or terminated vested employees remain within the plan.

It is true that some sponsors, a minority in our experience, express an interest in a more 

paternalistic approach to retired employees. They may see in-plan retirement income 

programs as part of that broader philosophy. Some sponsors also have an interest in 

retaining retired participants in their plan because older participants tend to have larger 

account balances. With a larger asset base, the sponsor is able to negotiate lower 

administrative fees for the plan. However, because an in-plan annuity option actually 

removes assets from the plan and transfers them to an insurer, an in-plan annuity option, 

by reducing assets, would actually reduce the plan sponsor’s price negotiating power. 

Overall our experience suggests that many sponsors would prefer to transition 

participants to outside-the-plan retirement income programs. In doing so, they can avoid 

the oversight duties involved with an in-plan option, and not worry about issues such as 

fiduciary risk, portability or costs. By providing appropriate education and advice 

services, they can educate participants about the challenges of financing lifetime income 

and about the benefits, risks and costs of strategies in the marketplace today, particularly 

those offered outside the plan. 

10. How commonly do plan sponsors offer participants the explicit choice of using a 

portion of their account balances to purchase a lifetime annuity, while leaving the 

rest in the plan or taking it as a lump sum distribution or a series of ad hoc 

distributions? Why do some plan sponsors make this partial annuity option 

available while others do not? Would expanded offering of such partial annuity 

options -- or particular ways of presenting or framing such choices to participants --

be desirable and would this likely make a difference in whether participants select a 

lifetime annuity option?

Among Vanguard DC recordkeeping clients, annuity payout options are rarely offered 

(see Question 3). Among the small group of money purchase plans offering annuity 

payout options, participants are not explicitly offered a choice between partial or full 

annuitization.
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We believe that reframing the decision in terms of partial annuitization is unlikely to alter 

participant behavior. Participants always have the option of annuitizing part of their 

savings at any time in the future; there is no immediate need, at the time of plan 

distribution, to consider making an irreversible one-time election to annuitize. At 

retirement, participants are also likely to be active decisionmakers and override annuity 

defaults (see Question 11). Moreover, because of preferences for liquidity and flexibility 

(see Question 1), participants are unlikely to annuitize.

11. Various “behavioral” strategies for encouraging greater use of lifetime income 

have been implemented or suggested based on evidence or assumptions concerning 

common participant behavior patterns and motivations. These strategies have 

included the use of default or automatic arrangements (similar to automatic 

enrollment in 401(k) plans) and a focus on other ways in which choices are 

structured or presented to participants, including efforts to mitigate “all or nothing” 

choices by offering lifetime income on a partial, gradual, or trial basis and exploring 

different ways to explain its advantages and disadvantages. To what extent are these

or other behavioral strategies being used or viewed as promising means of 

encouraging more lifetime income? Can or should the 401(k) rules, other plan 

qualification rules, or ERISA rules be modified, or their application clarified, to 

facilitate the use of behavioral strategies in this context?

We do not believe that a change in default arrangements – a so-called “nudge” strategy 

(Thaler and Sunstein, 2008) – will have a meaningful effect on annuitization rates. Our 

research suggests that retirees are likely to be actively engaged decision-makers and work 

energetically to overcome annuitization defaults. This behavior is in marked contrast to 

that during the accumulation phase of retirement savings. 

In a study of lump sum versus annuity choices in two large defined benefit plans, we 

found that most participants work actively to overcome the joint and survivor annuity 

default within the plan.6 In order to “opt out” of the annuity default, married participants 

must take their spouse to a face-to-face meeting with a notary public and pay a fee. Most 

do so and opt out of the statutory qualified joint and survivor annuity (QJSA) annuity 

default. Our belief is that the demand for flexibility and liquidity is so substantial that 

most participants will work actively to overcome default annuity strategies in retirement. 

We would also emphasize that default strategies in the accumulation phase like automatic 

enrollment are most successful with low-wage and young workers. By comparison, 

retirees leaving an employer-sponsored plan are a much broader group demographically, 

and they are in their peak asset accumulation years. Thus the decision-making dynamics 

of retirees are likely to be quite different than those of first-time savers. 

 

6

 Gary R. Mottola and Stephen P. Utkus. “Lump Sum or Annuity? An Analysis of Choice in DB Pension 

Payouts.” Vanguard Center for Retirement Research, November 2007. https://institutional.vanguard.com/

iip /pdf/CRRLSA.pdf. 
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Finally, we note that there has been no empirical evidence to date that default strategies 

might be effective in changing annuitization behavior. So the potential role of defaults 

and “nudging” is an area that might benefit from additional experimentation and analysis, 

before the ideas are enshrined in public policy. 

12. How should participants determine what portion (if any) of their account 

balance to annuitize? Should that portion be based on basic or necessary expenses in 

retirement?

Our view is that the portion of retirement assets to annuitize is based on the preference 

for a given level of guaranteed income in addition to Social Security (and any other

defined benefit pension income to which the household may be entitled). This desire for 

additional guaranteed income is not directly based on a participant’s age, income, account 

balance, retirement income goals, or the level of basic or necessary retirement income 

expenses. Instead it is based on the willingness to forego liquidity and flexibility with a 

given amount of savings in exchange for additional levels of guaranteed income. Thus, 

two households, in otherwise identical situations, may choose to annuitize different 

fractions of their assets (including not annuitizing at all), depending on this preference. 

Given the emphasis that many households place on flexibility and liquidity, as well as the 

desire to make bequests, we expect that demand for annuitization will continue to remain 

low, even in the face of recommendations to generate annuity income that covers “basic 

or necessary expenses.” It is possible that education programs about retirement income 

may enhance the demand for annuitization at the margin. Also, the declining prevalence 

of private pension annuity income may increase annuity demand somewhat. But we 

believe that preferences for flexibility and liquidity remain quite strong, and would

counterbalance recommendations to annuitize assets equivalent to all basic expenses in 

retirement. 

13. Should some form of lifetime income distribution option be required for defined

contribution plans (in addition to money purchase pension plans)? If so, should that 

option be the default distribution option, and should it apply to the entire account 

balance? To what extent would such a requirement encourage or discourage plan 

sponsorship? 

As noted in Question 1, we would question any policy rationale that favors a specific 

category of retirement income program, such as the traditional annuity contract, over any 

other. 

One possible reason for an annuity mandate would be to address concerns about 

longevity risk. However, today virtually all participants receive a meaningful level of 

longevity risk protection through Social Security. Also, there is no widely-accepted 

consensus surrounding the minimum amount of annuity income households should have 

in retirement. Lower-wage workers, who might be perceived as being most at risk, have 
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higher replacement rates from Social Security and lower asset levels. Rather than 

needing more annuitized income, they may wish to maintain control over any liquid 

assets they own. Finally, it is worth noting that in the United Kingdom, which has a 

mandatory annuity requirement, there is an active debate over its repeal. 

A second reason for avoiding mandates is expected participant behavior. Most 

households choose not to annuitize due to important concerns about liquidity and 

flexibility and insurer credit risk. We would highlight again (as noted in Question 1) the 

fact that the overwhelming majority of older participants exit their employer plan within 

three years upon termination of employment. It also seems unwarranted to mandate the 

complexity and cost of lifetime income solutions for the plan sponsor when there is little 

likelihood of participants using the income option in the qualified plan. 

 

A third reason for avoiding a mandatory approach is the innovation and dynamism of the 

current marketplace. This dynamism reflects the wide range of participant and sponsor 

preferences in the marketplace. In our view, it is not clear today whether systematic 

withdrawal plans, payout funds or various forms of annuities will win the day and 

become the preferred strategy for most participants. In fact, we expect that no single 

solution will dominate, and that individuals will construct a personalized retirement 

income plan from a range of options, including those beyond the purview of the qualified 

plan system (such as work earnings and reverse mortgages). From a policy perspective, it 

is premature to determine that a particular insurance or investment product is broadly 

applicable to most plan participants. 

Given these factors, we would recommend against any mandatory retirement income 

program in qualified plans. We would instead leave judgments about suitability of a 

given program to plan sponsors, who can evaluate the appropriateness of various 

strategies and decide whether or not they should be introduced to their participants. 

14. What are the impediments to plan sponsors’ including lifetime income options in 

their plans, e.g., 401(k) or other qualification rules, other federal or state laws, cost, 

potential liability, concern about counterparty risk, complexity of products, lack of 

participant demand?

Sponsor concerns about in-plan lifetime income options are described in Question 3. In 

some ways, the impediments to offering retirement income programs in qualified plans 

are less regulatory than inherent in the nature of the products being offered. Portfoliobased strategies like payout funds are relatively new, and sponsors are awaiting greater 

understanding of their dynamics before considering them for qualified plans. Annuity 

contracts impose their unique fiduciary requirements due to the inherent complexity of 

offering guarantees, their inherent illiquidity from insurer to insurer, the difficulty of 

apples-to-apples price comparisons, and, as noted earlier, low participant demand and 

possible misuse. Many sponsors also struggle with the complex task of evaluating the 

financial strength of an insurer. 
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15. What are the advantages and disadvantages of approaches that combine 

annuities with other products (reverse mortgages, long term care insurance), and 

how prevalent are these combined products in the marketplace?

Although we do not offer such products, we think that many types of innovative ideas 

will emerge in the retirement income marketplace. 

The case of reverse mortgages is a reminder that innovation is occurring along several 

dimensions. Most older Americans own a home, and despite the recent credit crisis, home 

equity is one of the substantial resources that households can draw upon in retirement, 

either for regular expenses or for unpredictable costs like health care costs. However, 

adoption of reverse mortgages is low, and it remains to be seen how widespread, if at all, 

such programs will become. 

As noted earlier in our analysis of various annuity-based programs, the challenge of many 

insurance-based products is complexity, lack of transparency in fees and costs, lack of 

liquidity and the risk of dealing with a single insurer or counterparty. These complexities 

seem even more daunting when combining retirement income with long-term care factors

or when evaluating a reverse mortgage.

16. Are there differences across demographic groups (for example men vs. women) 

that should be considered and reflected in any retirement security program? Can 

adjustments for any differences be made within existing statutory authority?

One of the challenges posed by annuity contracts is their inherent differential impact by 

various demographic factors. In any annuity contract, populations with shorter life 

expectancies will subsidize populations with longer life expectancies. Thus, men will 

subsidize women (except, arguably, in the case of within-plan annuities with standardized 

unisex pricing). Blacks and Hispanics will subsidize whites. Low-wealth and loweducation participants will subsidize high-wealth and high-education participants. 

Participants in poor health will subsidize those in good health. 

These examples again underscore the wide variation in participant needs when it comes 

to retirement income solutions. As noted in Questions 1 and 13, we believe that 

policymakers should avoid mandating any particular form of retirement income solution, 

such as a traditional immediate income annuity, and instead encourage a range of 

retirement income choices. 

17. What information (e.g., fees, risks, etc.) do plan participants need to make 

informed decisions regarding whether to select lifetime income or other 

arrangements designed to provide a stream of income after retirement? When and 

how (i.e., in what form) should it be provided? What information currently is 
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provided to participants, who typically provides it, and when and how is it provided 

to them?

Education programs. Vanguard plan participants receive education about retirement 

income strategies in a variety of ways – in web and print communications, and in online 

and in-person seminars – under DOL Interpretive Bulletin 96-1. Educational material 

typically describes strategies for calculating a reasonable withdrawal rate from retirement 

savings, along with a general description of annuities and other retirement income 

products. This information is typically offered as part of a broader part of a preretirement planning seminar.

Advice programs. Participants also receive retirement income advice through Vanguard 

Financial Planning Service, which is organized under the Pension Protection Act (PPA) 

advice provisions. While this service is offered to a wide range of participants, most who 

take advantage of it are approaching retirement age, when they are more actively engaged 

in planning their retirement. Vanguard Certified Financial Planners offer one-on-one 

counseling and a personalized financial plan. That plan includes recommendations on 

savings rates until retirement; the timing of retirement; investment allocations; and 

possible draw-down rates. 

Product information. At Vanguard, most retirement income products are offered in the 

IRA rollover market. When participants choose a Vanguard rollover, they receive 

specific information on benefits, risks and fees depending on the regulated product (e.g., 

FINRA and SEC disclosures for investment products, state and any federal disclosures as 

required for insurance products). This disclosure is complemented by related educational 

materials in print and on the web. The risks we discuss with participants are not limited to 

investment risks, but include others risks, such the lack of liquidity and insurer failure 

associated with insurance contracts. 

We anticipate substantial growth in our education and advice services for retirement 

income in the years ahead. Our view is that the retirement income marketplace is 

dynamic and changing rapidly. In order to make effective choices, participants need 

clear and simple communications regarding the benefits, risks, and costs of competing 

retirement income strategies.

18. Is there a need for guidance, regulatory or otherwise, regarding the extent to 

which plan assets can be used to pay for providing information to help participants 

make informed decisions regarding whether to select lifetime income or other 

arrangements designed to provide a stream of income after retirement, either via an 

in-plan or out-of plan option?

Education. We believe that the DOL should explicitly extend the purview of Interpretive 

Bulletin 96-1 to include educational materials governing the retirement income or 

distribution phase. In particular, we believe the DOL should confirm that persons 

engaged by a plan sponsor to provide these materials are not being hired as fiduciaries 
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with respect to the plan by virtue of providing this education to plan participants and 

beneficiaries, giving plan sponsors more comfort that they will not be second-guessed 

when these programs are offered. Such a step would be very helpful in encouraging plan 

sponsors to provide additional educational information for retirement income options. 

The plan sponsor is often perceived by the participant as a trusted and impartial source of 

information, and sponsors in our experience take their participants’ long-term interests to 

heart. Sponsors broadly remain concerned about the possibility that existing rules may 

present undue legal risks as they try to provide helpful and actionable education programs

for the retirement income phase. 

We also believe that guidance should explicitly encourage sponsors to educate their 

participants on out-of-plan options that may be available. This is particularly important 

given our finding that the overwhelming majority of retiring plan participants roll out of 

their employer-sponsored plan to an IRA within three years. Sponsors would like to help 

participants make informed outside-the-plan choices and to provide general education 

along those lines. But they are wary of being perceived as having endorsed a specific 

outside-the-plan product or firm; they are also concerned that an outside-the-plan product 

might be misconstrued as a de facto in-plan distribution option. So helping sponsors 

draw a clear line between broad education on retirement income, and specific product or 

issuer endorsements, would be extremely valuable. 

Advice. As noted in Question 1, we believe advice programs are also critical in helping 

participants make effective retirement income decisions. The Department of Labor is to 

be congratulated on its current effort to finalize regulations governing the provision of 

advice to DC plan participants. We encourage the Department to adopt final rules that 

are flexible enough to allow affiliated providers like Vanguard to be able to give advice 

to participants in both the accumulation and draw-down phases

19. What specific legal concerns do plan sponsors have about educating participants 

as to the advantages and disadvantages of lifetime income or other arrangements 

designed to provide a stream of income after retirement? What actions, regulatory 

or otherwise, could the Agencies take to address such concerns?

See Question 18.

20. To what extent should plans be encouraged to provide or promote education 

about the advantages and disadvantages of lifetime annuities or similar lifetime 

income products, and what guidance would be helpful to accomplish this?

See Question 18.
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21. Should an individual benefit statement present the participant’s accrued benefits 

as a lifetime income stream of payments in addition to presenting the benefits as an 

account balance?

Estimates of the future income from an individual account balance can be useful for 

participants when planning for retirement. Currently, most Vanguard DC plan 

participants receive an estimate of their potential monthly retirement income on their 

quarterly benefits statement.

However, we do not believe that income amounts based on annuity factors are 

appropriate for a number of reasons. Annuity income estimates do not convey the 

inherent risks of annuitization—including the loss of access and liquidity, the lack of 

flexibility, and the single-company default risk. When evaluating these risks today, few 

participants choose to annuitize. As a result, an annuity income amount on a statement 

can be misleading, as it overstates the actual income a participant is likely to draw from a 

portfolio. In addition, developing an annuity estimate requires complex assumptions 

about mortality rates, sales load factors and other annuity pricing variables. It can be 

challenging to make appropriate and realistic assumptions. 

Our own retirement income calculation on statements today is based on simple 

assumptions: the participant’s current balance, current contribution, an assumed real 

return of 4% per year after expenses, and a 4% withdrawal rate at retirement at age 65. 

Other recordkeepers are gradually adding these types of estimates to their systems for use 

by participants. We would advise against any policy that endorses an annuity income 

approach for the reasons outlined above. If policymakers are seeking to encourage such 

estimates, a better approach would be an income amount based on a simple withdrawal 

rate such as 4%. 

22. If the answer to question 21 is yes, how should a lifetime stream of income 

payments be expressed on the benefit statement? For example, should payments be 

expressed as if they are to begin immediately or at specified retirement ages? Should 

benefit amounts be projected to a future retirement age based on the assumption of 

continued contributions? Should lifetime income payments be expressed in the form 

of monthly or annual payments? Should lifetime income payments of a married 

participant be expressed as a single-life annuity payable to the participant or a joint 

and survivor-type annuity, or both?

These are some of the complex factors that argue against choosing an annuity factor as 

the income amount on participant statements. As noted in Question 21, we would 

encourage a simple withdrawal factor. In our view it is most meaningful to illustrate the 

stream of lifetime income payments as a monthly withdrawal amount beginning at a 

specified retirement age based on the assumption of continued contributions and 

reasonable investment returns. 
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23. If the answer to question 21 is yes, what actuarial or other assumptions (e.g., 

mortality, interest, etc.) would be needed in order to state accrued benefits as a 

lifetime stream of payments? If benefit payments are to commence at some date in 

the future, what interest rates (e.g., deferred insurance annuity rates) and other 

assumptions should be applied? Should an expense load be reflected? Are there any 

authoritative tools or sources (online or otherwise) that plans should or could use 

for conversion purposes, or would the plan need to hire an actuary? Should caveats 

be required so that participants understand that lifetime income payments are

merely estimates for illustrative purposes? Should the assumptions underlying the 

presentation of accrued benefits as a lifetime income stream of payments be 

disclosed to participants? Should the assumptions used to convert accounts into a 

lifetime stream of income payments be dictated by regulation, or should the 

Department issue assumptions that plan sponsors could rely upon as

safe harbors?

These are some of the complex factors that argue against choosing an annuity factor as 

the income amount on participant statements. As noted in Question 21, we would 

encourage a simple withdrawal factor. 

24. Should an individual benefit statement include an income replacement ratio 

(e.g., the percentage of working income an individual would need to maintain his or 

her pre-retirement standard of living)? If so, what methodology should be used to 

establish such a ratio, such as pre-retirement and post-retirement inflation 

assumptions, and what are the impediments for plans to present the ratio in a 

meaningful way to participants on an individualized basis? 

A participant’s account with his or her current employer represents only a portion of the 

total retirement picture for that participant’s household. Most American workers with 

qualified plan coverage have participated in different plans over their working career; 

their assets are likely to be invested in a variety of qualified plan and IRA accounts. 

Many participants are married and so the participant view is not the household view. 

As a result, estimating “retirement readiness” or “retirement sufficiency” from a current 

account balance with a given employer is most useful for a small minority of

households—those who have been with a single employer, and in a single benefit plan, 

for most of their working career, and those for whom the participant’s own benefits 

represent the overwhelming majority of the household’s benefits. For most households,

estimating “retirement readiness” requires a detailed planning exercise, using software 

tools or consulting with a financial planner, and incorporating all benefits and accounts.

Nonetheless, we believe that estimating the future income from a specific plan account 

balance, as in Question 21, can be a valuable tool for plan participants. The future value 

encourages participants to think about retirement and the future in general; it also helps 

participants translate a given account balance into a possible income stream and factor 
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that into their retirement planning. But that value alone cannot answer whether the 

participant is “ready”—or not—for retirement.

25. How do the 401(k) or other plan qualification rules affect defined contribution 

plan sponsors' and participants' interest in the offering and use of lifetime income? 

Are there changes to those rules that could or should be made to encourage lifetime 

income without prejudice to other important policy objectives?

In our experience, most employers view the notice and consent rules of Internal Revenue 

Code (IRC) section 417 for qualified joint and survivor annuities (QJSA) to be overly 

complex and burdensome. For this reason, many DC plans were amended in recent years 

to eliminate annuity options after the issuance of the regulatory guidance on the issue.

7

 

The QJSA rules were introduced as a matter of equity to women (ensuring some residual 

benefits would be paid to surviving spouses) and in an effort to promote annuitization. 

However, in our experience, even in money purchase plans where the QJSA feature is 

retained, the participant waiver and spousal consent requirements necessary have proven 

to be ineffective in encouraging participants to select an annuity form of payment. In 

addition, demographic shifts, as evidenced by women’s increasing participation in the 

workforce, are reducing the need for spousal income protection. As a result, our 

recommendation to policymakers would be to eliminate the QJSA requirements for the 

one group of DC plans still subject to them, namely money purchase plans.

26. Could or should any changes be made to the rules relating to qualified joint and 

survivor annuities and spousal consents to encourage the use of lifetime income 

without compromising spousal protections?

See question 25.

27. Should further guidance clarify the application of the qualified joint and 

survivor annuity rules or other plan qualification rules to arrangements in which 

deferred in-plan insurance annuities accumulate over time with increasing plan 

contributions and earnings?

Our defined contribution plan clients currently do not use deferred annuity contracts 

within their retirement plans. 

28. How do the required minimum distribution rules affect defined contribution 

plan sponsors' and participants' interest in the offering and use of lifetime income? 

 

7

 See Treas. Reg. §1.411(d)-4, Q&A-2(e) in September 2000, and the addition of IRC §411(d)(6)(E) to the 

Code by EGTRRA, both permitting the elimination of periodic payment options from most defined 

contribution plans.
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Are there changes to those rules that could or should be made to encourage lifetime 

income without prejudice to other important policy objectives? In particular, how 

are deferred annuities that begin at an advanced age (sometimes referred to as 

longevity insurance) affected by these rules? Are there changes to the rules that 

could or should be considered to encourage such arrangements?

As a matter of federal tax policy, required minimum distributions (RMDs) were designed 

to generate some level of taxable income from tax-deferred accounts for the U.S. 

Treasury while the participant is living in retirement. However, RMDs can also be used 

to generate a simple income stream from a qualified plan account or IRA after age 701⁄2 . 

That income stream is not guaranteed nor necessarily inflation-adjusted, nor does it carry 

a longevity guarantee. But RMD payments are a straightforward way to receive some 

income from a tax-qualified account at older ages. 

RMD rules pose a challenge for other types of retirement income programs. In the case 

of portfolio-based strategies, such as systematic withdrawal plans or payout funds, the 

amount of withdrawal required under a given plan may be lower than the RMD in a given 

year. As a result, the RMD rules create confusion for the participant who must receive 

“extra” income due to the RMD regulations. One policy remedy would be to amend 

regulations under IRC §401(a)(9) that would expand acceptable methods for calculating 

RMDs to include distribution amounts determined in connection with a broader array of 

account payouts, such as common systematic withdrawal programs or payout funds. 

In the case of annuities, annuity income streams are not credited against RMDs. Thus, an 

individual who annuitizes a portion of his or her savings must still begin RMDs from the 

remaining assets at age 701⁄2, even if the annuity payouts are larger than what the RMDs 

would have been for the entire lump sum. Annuity payouts should be credited against 

required RMDs from the remaining non-annuitized assets.

Changes lie these would substantially increase the complexity of RMD rules. A better 

alternative would be to repeal the existing RMD rules and replace them, instead, with 

rules governing the taxation of benefits upon receipt of the beneficiary. We acknowledge 

that such a policy change may be scored as costly in the government’s current budget 

window. However, changing the rules represents only a timing difference. All things 

being equal, the revenue lost by Treasury from repeal of RMDs today is likely to be 

recouped, in present value terms, from higher taxes in the future paid by beneficiaries on 

larger balances. 

29. Are employers that sponsor both defined benefit and defined contribution plans 

allowing participants to use their defined contribution plan lump sum payouts to 

"purchase" lifetime income from the defined benefit plan? Could or should any 

actions be taken to facilitate such arrangements? Should plans be encouraged to 

permit retirees who previously took lump sums to be given the option of rolling it 

back to their former employer's plan in order to receive annuity or other lifetime 

benefits?
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The strategy of purchasing DB income with a DC balance is yet another option that some 

participants can use. A few large employers promote such an option to their participants 

today. In general, our preference is for greater choice and flexibility for households 

making retirement income decisions, so any steps to advance the use of these or other 

income strategies we view as useful. At the same time, we note that the number of 

participants affected by this specific strategy is likely to be small, and providers equipped 

to offer this service may be few in number. 

30. To what extent do fiduciaries currently use the safe harbor under 29 CFR 

2550.404a-when selecting annuity providers for the purpose of making benefit 

distributions?

We have no data on how many sponsors explicitly rely on the safe harbor rule when 

selecting an annuity provider for a DC plan. Our general observation is that sponsor 

concerns about in-plan annuity features, discussed in Question 3, have not been 

materially altered by the new regulations.

31. To what extent could or should the Department of Labor make changes to the 

safe harbor under 29 CFR 2550.404a-4 to increase its usage without compromising 

important participant protections? What are those changes and why should they be 

made?

The current safe harbor underscores the principle that sponsors have a duty to select and 

monitor annuity contract providers—no different than having a duty to select and monitor 

investment managers for the plan. 

It seems to us that the major challenge in fulfilling this duty is not regulatory but 

substantive to the decision being made. Sponsors find it difficult to evaluate the credit 

quality of insurers, and find it difficult to obtain competitive pricing information on an 

apples-to-apples basis. It could be that the marketplace will evolve over time and these 

hurdles will be overcome. For example, some recent “annuity marts” offer comparability 

of annuity pricing across vendors, although these products are offered outside the plan 

and not as an in-plan arrangement. But the inherent difficulty of selecting annuity 

providers lies in evaluating the ability of any institution to fulfill its promises over long 

periods, plus issues of pricing transparency, comparability and liquidity. 

32. To what extent could or should the safe harbor under 29 CFR 2550.404a-4 be 

extended beyond distribution annuities to cover other lifetime annuities or similar 

lifetime income products? To which products should or could the safe harbor be 

extended?
Responses to Request for Information Questions: (RIN 1210-AB33) 

- 23 - 

It would seem appropriate to extend the safe harbor to any retirement income program 

with a guaranteed, life-contingent payout – one backed by the creditworthiness of a stateregulated insurer. Thus, the safe harbor might apply to deferred annuity contracts, to 

living benefit annuity riders, and to other insurance-based contracts. As noted above in 

Question 31, much of the complexity in evaluating these insurance contracts from a 

fiduciary perspective does not arise from the regulatory requirements but instead is 

inherent in the type of evaluation being made. 

33. To what extent are fixed deferred lifetime annuities (i.e., incremental or 

accumulating annuity arrangements) or similar lifetime income products currently 

used as investment alternatives under ERISA 404(c) plans? Are they typically used 

as core investment alternatives (alternatives intended to satisfy the broad range of 

investments requirement in 29 CFR 2550.404c-1) or non-core investment 

alternatives? What are the advantages and disadvantages of such products to 

participants? What information typically is disclosed to the participant, in what 

form, and when? To what extent could or should the ERISA 404(c) regulation be 

amended to encourage use of these products?

Among Vanguard DC plans, neither fixed nor variable deferred annuity contracts are 

currently being used as investment options. Sponsors’ general concerns with deferred 

annuity contracts are summarized in Question 4. 

34. To what extent do ERISA 404(c) plans currently provide lifetime income 

through variable annuity contracts or similar lifetime income products? What are 

the advantages and disadvantages of such products to participants? What 

information about the annuity feature typically is disclosed to the participant, in 

what form, and when? To what extent could or should the ERISA 404(c) regulation 

be amended to encourage use of these products? 

Among Vanguard DC plans, neither fixed nor variable deferred annuity contracts are 

currently being used as investment options. Sponsors’ general concerns with deferred 

annuity contracts are summarized in Question 4.

35. To what extent are plans using default investment alternatives that include 

guarantees or similar lifetime income features ancillary to the investment fund, 

product or model portfolio, such as a target maturity fund product that contains a 

guarantee of minimum lifetime income? What are the most common features 

currently in use? Are there actions, regulatory or otherwise, the Agencies could or 

should take to encourage use of these lifetime income features in connection with 

qualified default investment alternatives?

Over 85% of Vanguard DC plans designating a qualified default investment alternative 

(QDIA) have chosen target-date funds as their qualified default; the remainder have 
Responses to Request for Information Questions: (RIN 1210-AB33) 

- 24 - 

chosen a traditional balanced option. Given the range of retirement income strategies that 

participants can choose from, either portfolio- or annuity-based, no Vanguard plan 

sponsors have chosen to add a QDIA with a specific retirement income feature. Rather, 

at retirement, participants in a Vanguard QDIA can choose to take a variety of steps, such 

as taking systematic withdrawals from their qualified plan or IRA rollover account, 

utilizing portfolio-based payout funds, rolling over to an IRA annuity contract, or some 

combination of these. 

As noted in Question 4, we believe it is generally inappropriate to attach a lifetime 

guarantee feature within a QDIA. QDIAs are used principally in automatic enrollment 

arrangements, which disproportionately affect younger- and short-tenured employees. 

Such employees are unlikely to remain in their current employer plan until retirement, 

and they would be ill-advised to incur the costs for a guarantee that they are highly 

unlikely to benefit from. In the marketplace today, there are sponsors who have chosen 

to add investment options that incorporate a lifetime guarantee element. These may be 

more suitable for older individuals who are more interested in paying for a guarantee and 

who expect to annuitize or otherwise convert their balance to a guaranteed income stream 

at retirement. Given the costs of these features, they should be offered only on a 

voluntary choice basis. 

In addition, as noted in Questions 3 and 4, sponsors remained concerned with adding 

annuity contract features in their plan. These include issues of fiduciary oversight, 

contract liquidity, portability, fees, complexity and participant demand. 

36. What are the costs and benefits to a plan sponsor of offering lifetime annuities or 

similar lifetime income products as an in-plan option? Please quantify if possible.

Each new retirement income product added to a plan recordkeeping system requires a 

meaningful technology investment. Changes must be made to the core recordkeeping 

system. Enhancements are needed to the desktops of service associates. The product 

must also be communicated to participants, requiring changes to print communications

and education programs, websites and statements, and tax reporting. Sponsor reporting 

must be enhanced. Over time, we find that adding a new product category leads to 

demand for additional service enhancements over time. 

Retirement income products vary from company to company, and often come with 

unique features and benefits and technology requirements. As a result, there are few 

economies of scale among the products being offered; at least today, these costs are 

incurred per type of product offered. 

Besides these recordkeeping costs, many sponsors would likely incur expenses for 

selecting and monitoring retirement income products and services. These costs would 

include fees to consultants or other experts to assist in the evaluation of these options. 
Responses to Request for Information Questions: (RIN 1210-AB33) 

- 25 - 

With over 60 million defined contribution plan participants in the U.S., the initial cost of 

offering a single product across the defined contribution plan system might be therefore 

$60 to $240 million per product. Of course, no single product will be offered by all 

recordkeepers. Assuming 10 widely used products, the maximum cost might be $600 

million to $2.4 billion. At some point, industry standardization could lead to reduced 

costs and economies of scale.

37. Are there unique costs to small plans that impede their ability to offer lifetime 

annuities or similar lifetime income products as an in-plan option to their 

participants? What special consideration, if any, is needed for these small entities?

Small DC plans generally pay higher all-in fees because they lack the economies of scale 

of large plans. If small plans decide to offer certain guaranteed income products, such as 

deferred or immediate income annuities, the guarantee costs will be added to their already 

above-average recordkeeping and investment management fees. Moreover, small plans 

will lack the negotiating power of large plans to drive down such costs.

As a result, participants in small plans will face even higher fees in guaranteed options, 

even though few participants in those options are likely to annuitize and benefit from the 

guarantee fees. Certain retirement income solutions thus risk raising fees among smaller 

plan participants, with only little marginal benefit. 

Paradoxically, some retirement income solutions are more likely to be offered to small 

plans because that segment of the recordkeeping market is more likely to be served by 

insurance companies.

38. Would making a lifetime annuity or other lifetime income product the default 

form of benefit payment have an impact on employee contribution rates? If so, in 

which direction and why?

We believe that making a traditional lifetime income option the default form of benefit 

payment will only marginally change the rate of annuitization. Most participants in our 

view are likely to work actively to avoid annuitization. If the default lifetime income 

option is liquid – such as a systematic withdrawal program, payout fund, or newer types 

of annuities offering liquidity – more participants will be likely to remain with the default 

option. As noted in Questions 1 and 2, liquidity and flexibility are critical factors for 

participants in making retirement income choices.

We would expect that a default payout option is unlikely to affect employee 

contributions. If the default is illiquid, as is the case with a standard annuity contract, we 

would anticipate that most employees would opt out of the default. See Question 11. If 

the default is liquid, participants will not view the default designation as restrictive.

However, if annuities were to become the mandatory form of distribution, we would 

expect participants to reduce their contributions to qualified plans in order to avoid being 

forced to annuitize their benefits. 
Responses to Request for Information Questions: (RIN 1210-AB33) 

- 26 - 

39. For plans that offer lifetime annuities or similar lifetime income products, what 

percentage of eligible workers elect to annuitize at least some of their retirement 

assets and what percentage elect to annuitize all of their assets?

Among Vanguard money purchase pension plans offering a QJSA annuity option, we 

observe no material rate of participant annuitization. In a study of two large DB plans, 

where annuitization is the default, we found that 27% of participants in a final average

pay plan remained with the annuity default, while 17% of participants in a cash balance 

plan remained with the annuity. A total of 78% and 83% of participants, respectively, 

opted out of the QJSA default and chose a lump sum. See Question 3.
Authors

John Ameriks, Ph.D

Liqian Ren, Ph.D

Connect with Vanguard > www.vanguard.com

Generating Guaranteed Income: 

Understanding Income Annuities

Vanguard Investment Counseling & Research 

Executive summary. Income annuities are a form of insurance intended to 

address the uncertainty investors face when planning for income for the rest 

of their lives—a length of time they cannot accurately predict. In exchange for

permanently surrendering access to a portion of their assets, annuitants can 

receive a stream of income as long as they live. 

Income annuities are not appropriate for all investors. Annuities are insurance, and

prospective buyers need to weigh the value of that insurance against the costs and

risks that arise from provider fees, tax treatment, and the illiquid nature of an income

annuity. This paper looks in depth at both sides of the question. To help clarify the

costs and risks, we analyzed annuity pricing as well as the less-tangible costs, such

as illiquidity, associated with an annuity purchase. To help assess the potential value

of annuities, we tested their usefulness in a variety of hypothetical scenarios, using

extensive historical market data to simulate conditions that real retirees might face. 

Our analysis indicates that for those investors who strongly desire the simplicity 

of regular monthly payments, who are concerned about maintaining their spending

levels very late in retirement (into their 90s and beyond), and who find the costs 

and risks acceptable, low-cost income annuities can be of value when used as 

a part of a broader investment and spending plan.
Introduction

Uncertainty about potential longevity creates risk 

for those who must rely on financial assets to

generate income in retirement. If retirees spend 

too much of their resources early on, they risk 

being forced to accept a lower standard of living 

in their later years. If they spend too little, they 

may experience an unnecessarily low standard 

of living throughout retirement and risk leaving 

a significant unplanned bequest.1

Income annuities are a form of insurance that 

reduces financial uncertainty related to potential

longevity. Almost everyone is familiar with life

insurance, which pays benefits in the case of a 

short lifespan. An income annuity is, fundamentally,

simply a reverse form of life insurance: It pays

benefits in the event of a long lifespan.

Although the operation of the product is seemingly

simple, the issues that must be considered in

evaluating annuitization are highly complex. The

psychological and practical benefits offered by the

promise of regular, guaranteed income payments

come with significant financial costs and some risks,

which investors need to fully understand and carefully

consider. The costs include potentially high provider

fees, loss of access to assets, and tax disadvantages

relative to other funding mechanisms; the risks

include the possibility of leaving a diminished estate.2

In this paper we look at how those costs and risks

could affect the annuity decision for retirees in various

circumstances. To provide context, we first give a

broad overview of annuities, focusing on the way they

operate and their potential use in managing longevity

risk. The paper goes on to examine annuity risks and

costs, including both explicit charges and those that

are less obvious, such as illiquidity and potential tax

impact. It then describes the results of our scenario

analysis, which focused primarily on the question 

of how income annuities could help retirees sustain 

desired spending levels over many years. We also

examined the potential impact of an annuity purchase

on a retiree’s estate.

Our analysis suggests that investors must be willing

to pay potentially significant insurance and tax costs,

in addition to sacrificing some investment liquidity, 

in order to obtain the benefit that income annuities

provide. However, if these costs and risks are

acceptable, if the potential for long life is significant,

and if the prospective value of systematic lifelong

payments is high, income annuities can be useful 

as a part of a complete financial plan.

Who should and should not 

consider annuitization

The analysis that follows is very detailed, and 

provides a great deal of background on how 

annuities operate and where annuity costs 

come from. We can summarize much of the 

content in four statements:

1. The longer one expects to live, the higher the

implicit rate of return on an income annuity.

Like all forms of insurance, annuities “pay off” 

only if the risk they insure against is realized. 

For an annuity to make sense, an investor must

believe there is a significant possibility that he 

or she could live well past the life expectancy of

the average annuitant—keeping in mind that the

average annuitant lives longer than the average

person in the U.S. population.3

2. Those in poor health generally should not 

consider annuitization. People whose life

expectancy is short because of poor health do 

not ordinarily receive higher annuity payments 

to reflect this situation. Annuities are therefore

significantly more costly for them relative to the

anticipated benefit. Recently, a few providers 

have begun to offer health assessments that 

could lead to higher payouts for those with

demonstrably poor health, but this practice 

is still rare.

2 > Vanguard Investment Counseling & Research

1 The potential for life-annuity arrangements to provide significant economic value to risk-averse investors without bequest motives in a basic life-cycle model

was demonstrated in a seminal article by Menahem Yaari (1965). Economists have subsequently shown that at least partial annuitization may add value even

when many of the restrictive assumptions of this simplified modeling framework are relaxed (Davidoff, Brown, and Diamond [2005]).

2 Assuming that no offsetting estate planning is undertaken.

3 See Brown et al. (2001) for a discussion of annuitant versus population mortality.
3. Income annuities are appropriate only for 

those who can afford to permanently lose 

access to some of their wealth. Income 

annuities are generally illiquid and irreversible, 

so the purchaser must retain sufficient liquid

assets to meet unforeseen needs. Because 

of this need for liquidity, and because virtually 

all investors already have significant annuity

income in the form of Social Security, only a

fraction of liquid financial wealth should be

considered eligible for annuitization.

4. Compared with a program of systematic

withdrawals from an investment portfolio,

annuities can result in a significantly higher 

tax cost for investors in higher brackets. This 

is because annuity payments are treated as 

regular income for taxation purposes, regardless 

of whether the source is realized capital gains,

interest income, or dividend payments (and 

leaving aside any untaxed “return of capital” 

to the annuitant). 

The nature of longevity risk

The first step in understanding annuities is

understanding longevity risk, which arises from the

simple fact that the human lifespan is uncertain. As

retirement approaches, many investors perceive that

the relative importance of this uncertainty increases. 

Idiosyncratic longevity risk: 

Lifespans for individuals and couples

Figure 1 illustrates longevity risk as confronted by a

typical 65-year-old male retirement plan participant in

2007. It shows the estimated distribution of lifespans

among such participants, based on data from large

pension plans assembled by the Society of Actuaries

(SOA).4 Age at death is shown along the horizontal

axis, and a probability measure of the frequency of

deaths is shown along the vertical axis. These data

show that a healthy male participant at age 65 could

expect, with roughly 50 percent probability, to live to

age 82 or beyond. From a statistical viewpoint, the

participant’s life expectancy would be 82—the mean

among the possible lifespans in the chart.5

Vanguard Investment Counseling & Research > 3

4 Data are from the SOA’s RP-2000 table adjusted to reflect a 65-year-old in 2007. We used the SOA data rather than overall U.S. population statistics because, 

in our view, the SOA data more closely reflects the population of investors who possess significant retirement assets and might realistically consider income

annuities. On the other hand, we drew on general-population data to obtain the rate of mortality improvement used in adjusting the RP-2000 data for 2007. 

5 Life expectancy is commonly defined as the mean age that individuals in a given population are expected to attain before death. 

Figure 1. Distribution of lifespans for male retirement plan participants aged 65 in 2007

0

1

2

3

4

5

6%

Percentage of 65-year-olds

Age

Source: Authors’ calculations based on data from the Society of Actuaries RP-2000 mortality table.

“Life expectancy” is age 82.5, the mean 75th percentile

Standard deviation: 8.4 years 

95th percentile

65 69 71 73 75 79 67 77 81 83 85 87 89 91 93 95 97 101 103 105 107 109 113 115 99 111
The data also show, of course, that this “life

expectancy” is simply one of many ages that he 

might reach. In fact, the chance that the 65-year-old

will actually die at age 82 is only about 4.2%. The

variation that exists around this age—the longevity

risk that he faces—is significant in both its size and 

its implications for planning. In terms of magnitude,

the standard deviation of lifespan for 65-year-old men

is estimated to be between 8 and 9 years for single

individuals.6 More than 25% of male retirees will live

past age 87, and 5% will live past 95. For females, 

the likelihood of living to each of these ages is 

even higher.

For a couple, the picture changes somewhat. 

Figure 2 shows the estimated distribution of 

ages at death for the longest-lived member of a

couple, again based on SOA data. The shape of this

distribution looks quite different from those of either

males or females separately. It much more closely

resembles a classic bell curve. The mean is closer 

to the center, and the standard deviation (7.2 years) 

is 0.8 year below the equivalent figure for males and

1.1 year below that for females. So even though the

mean is higher—on average, at least one member 

of a couple will make it to age 89—uncertainty is

relatively lower than for either gender separately. 

4 > Vanguard Investment Counseling & Research

6 Note that standard deviation does not measure the skewness in the distribution. To adequately assess the uncertainty in the distribution, one must look at the

full set of potential outcomes and their probability as a whole.

Figure 2. Distribution of lifespans for couples: Male and female retirement plan participants aged 65 in 2007

0

1

2

3

4

5

6%

Percentage of 65-year-olds

65 69 71 73 75 79 67 77 81 83 85 87 89 91 93 95 97 101 103 105 107 109 113 115 99 111

Age

Note: This chart is based on data derived from the SOA’s data on individual life expectancies. It assumes that each couple consists of a man and a woman; 

it also assumes that their lifespans are independent. (There is evidence that mortality rates rise at least temporarily following the death of a spouse, but the 

magnitude of this bereavement effect is unclear. See, for example, Korenman et al [1997].)

Source: Authors’ calculations based on data from the Society of Actuaries RP-2000 mortality table.

75th percentile

“Life expectancy” is age 89

Standard deviation: 7.2 years

95th percentile
This important distinction between mean (life

expectancy) and the range of possible variation

around that mean (the potential to live far longer 

or die much sooner than expected) is often missed

when longevity issues are discussed in the popular

press. For example, it is true that women face 

greater longevity risk than men. But this is not

because women can expect to live longer on 

average; rather, it is because they display more

potential variation in lifespan than men do. Likewise,

the members of a couple can be said to face less

longevity risk than a single person, despite the fact

that the couple expects greater longevity (at least 

for one member). This results from the diversification

of longevity risk within the couple, and a lower level

of uncertainty regarding the length of the period 

they must plan for.7

Aggregate longevity risk:

Broad shifts in mortality patterns

In addition to the uncertainty in lifespan that is 

implied by these data, another type of longevity risk 

is important. This is the risk that everyone might live

longer than expected—i.e., the risk that mortality

projections could understate the true distribution 

of lifespans going forward. For example, a medical 

or genetic advance could occur, enabling people 

to live for ten more years in retirement on average,

improving their physical health but increasing the 

risk to their financial health. Such aggregate 

risk cannot be diversified away in a risk-sharing

arrangement; however, it can be transferred to

someone else through a financial contract. The 

entity accepting this risk must, of course, either

hedge the risk or possess the financial resources

necessary to fulfill its commitments should the

unexpected event occur. 

Through the income annuities that they provide,

insurance companies, pension funds, and state and

federal governments therefore play two roles: They

provide the means for efficient diversification of

idiosyncratic longevity risk through pooling, and they

offer to accept and bear aggregate longevity risk.8

Dealing with longevity risk

The most straightforward way to deal with either kind

of longevity risk is for each individual to bear it alone.

Such approaches are often called self-insurance (or

“self-annuitization”). 

Financial planners and professionals are increasingly

recognizing the importance of longevity risk, and 

they now frequently use analytical tools to help

clients find a “safe” spending rate that minimizes 

the chance of depleting resources late in life. In

practice, this means first choosing a long planning

horizon (say 30–40 years for a 65-year-old), and then

finding the amount of spending that can be supported

over that span with satisfactorily high probability.

Several recent quantitative studies have used

simulation techniques to do this type of analysis;

most point to the need to withdraw less than 5% 

of a portfolio balance in the first year, then adjust 

that amount for inflation each year thereafter, in 

order to safely fund withdrawals over periods of 

30 years or more.9

For those who see no disadvantage in adhering 

to such a spending level, who desire to maintain

considerable liquid wealth, who are comfortable 

with the idea of leaving any unspent assets in their

estate, and who are not worried about horizons longer

than 30 years, this solution is simple and extremely

flexible. If spending is kept low enough, the risk that 

it will need to be cut even further late in life can be

virtually eliminated. The cost of reducing longevity 

risk is simply spread throughout retirement via a

reduction in spending.

Vanguard Investment Counseling & Research > 5

7 The impact of the diversification and sharing of risk across family members is discussed in detail by Kotlikoff and Spivak (1981).

8 Technically none of these organizations truly “bear risk”; instead, their owners or shareholders do. In the case of government entities, the “owners” are the

taxpayers. In the case of insurers, the owners are either the company’s shareholders and creditors or its policyholders (in a mutual arrangement). Such sharing 

of diversified risk across large groups lowers the risk to which any one owner is exposed, which creates significant economic value. See Samuelson (1963).

9 See for example Bengen (1994), Pye (2000), and Ameriks, Veres, and Warshawsky (2001). For a more advanced treatment, see Huang, Milevsky, and 

Wang (2004).
Annuity definitions

The word annuity has come to mean a variety of

things, and many consumers are confused about

exactly what an annuity is. Figure 3 provides a 

basic outline of the different types of annuities. 

A basic distinction must be made between 

immediate (or income) annuities and deferred

annuities. A deferred annuity is essentially a taxfavored investment account bundled with the right 

to purchase an income annuity at a future date.

Deferred annuities provide tax-deferred accumulation

similar to that offered by a traditional IRA, but can

have high costs that significantly erode this benefit.

An analysis of deferred annuities is beyond the 

scope of this article, and we will not discuss 

them further.10

An immediate annuity, or income annuity, is a socalled “payout” contract whereby the policyholder, 

or annuitant, is promised a sequence of payments

made according to specified rules and conditions in

exchange for a lump-sum purchase price. An income

annuity is a spending vehicle rather than a saving

vehicle. It comes in two flavors: A term-certain

annuity may involve payments that continue for 

only a set period; a life annuity offers payments 

that continue as long as an annuity owner is alive 

to receive them.

This paper is concerned exclusively with incomegenerating life annuities, in which payments 

are made to one or more annuitants as long as 

they are alive. We focus solely on life annuities

because they are the only annuity products that 

serve to transfer longevity risk from the purchaser 

to the annuity provider, directly addressing this key

concern of retirees. Throughout this paper, therefore,

“annuity” means “income-producing life annuity”

unless we specify otherwise.

Within the class of life annuities, a further distinction

exists between fixed annuities, which promise a

certain dollar amount at each point in the future, and

variable annuities, which promise to yield an unknown

(but formula-based) amount via payments that will

fluctuate depending on asset returns over time. Thus,

fixed annuities provide “rate of return” insurance,

while variable annuities do not. However, both types

of life annuity provide “longevity insurance” by

promising payments regardless of how long an

annuitant lives.

6 > Vanguard Investment Counseling & Research

10 For an analysis of deferred annuities as savings vehicles, see Milevsky (2001).

Figure 3. Annuity taxonomy

Categorization Description Function Income annuities Term-certain annuities Life annuities

Fixed The standard, plain-vanilla income annuity. A fixed amount is paid Rate-of-return and longevity insurance.

 periodically as long as the annuitant lives.

Variable The annuitant chooses the investments and receives formula-based Longevity insurance only.

 income payments until death.

Fixed A fixed amount is paid to the annuitant, or to the annuitant’s estate Rate-of-return insurance only.

or beneficiaries, for a fixed period.

Variable The annuitant chooses the investments and receives formula-based No real insurance function.

income payments for a fixed period.

Deferred

annuities

Fixed An option to buy an income annuity at a later date, using tax-deferred Limited rate-of-return and longevity insurance.

 savings that grow at a fixed rate to do so.

Variable An option to buy an income annuity at a later date, using a variety of Limited longevity insurance.

 tax-deferred investments to do so.

There are also gift and charitable-remainder annuities, as well as a variety of options and riders that can be added to these contracts at a cost. 

This paper focuses only on the most basic, standard arrangements for life annuities as described above.

Source: Vanguard Investment Counseling & Research. 
But for those who find the strategy of reduced

spending unattractive, and who are comfortable

sacrificing at least some investment liquidity, a

different solution may be desirable. A mechanism 

that allows them to manage longevity risk by 

reducing their level of liquid wealth, rather than 

their periodic spending, could make them better 

off. Income annuities aim to provide this solution.

How do annuities work?

How can an annuity provider promise to make

payments potentially far in excess of the original

purchase price? This is possible because of the way

annuities are structured. Simply put, these contracts

are designed to let a provider use the assets of 

those whose lives are shorter than expected to

finance payments to those whose lives are longer

than expected. 

This implicit transfer of resources to living annuitants

during each period they survive constitutes a “longevity

credit” that has the potential to make the rate of

return on an income annuity higher than the rate that

one could receive from a nonannuitized investment—

if the annuitant lives long enough.

The price of an annuity

Theoretically, the price of a life annuity is based 

on a simple present-value calculation using a set 

of discount rates and a set of assumptions about

longevity. (See Appendix A for the basic formula.)

Insurers set the prices of annuities based on their

assessment of the longevity risk of a prospective

purchaser and a rate of return that they believe they

can achieve. Purchasers, on the other hand, value

annuities based on their personal assessments of 

the longevity risk they face and of the rate of return

that they might achieve on their own. These numbers

may be substantially different from those used by 

the annuity provider. This difference represents an

expected cost (or premium) that any prospective

purchaser must assess when making a decision 

about investing in an annuity. 

Fixed versus variable payments:

What’s a guarantee worth?

Many retirees recognize that a guaranteed level of

income does not equate to a guaranteed lifestyle.

Inflation and other adverse developments can hamper

the ability of those on a fixed income to maintain 

their living standards over time. In fact, because a

person or family’s standard of living is linked to the

purchase of a specific, unique set of goods and

services, there is no income source in existence 

that can truly guarantee to preserve it indefinitely.11

Indeed, it is unclear what value (besides the

psychological one) is truly offered to retirees by

guarantees of fixed dollar payments over a lifetime.

Given ongoing variability in both prices and spending

needs, many people might do better by continuing 

to share in the risks and returns of a well-chosen 

and diversified set of investments as a resource 

for their cash flow. Compared with fixed payments,

certain assets may be more volatile but also may

provide a far better means to hedge spending risks

such as inflation over long periods. In addition,

retirees naturally vary in their ability to tolerate 

the ups and downs of financial markets over time.

While some may strongly desire very low volatility 

in their investments and spending, others may 

prefer some exposure to such volatility if it gives 

them a reasonable expectation of higher average

investment returns. 

That kind of exposure can be provided by variable

income annuities, in which payment levels are not

guaranteed. With these products, the assets used 

to purchase the annuity are held in investments

chosen by the annuitants and may have an uncertain

rate of return. The risks and returns associated with

the investments are passed through to annuitants

through the use of the variable annuity payment

formula (described in Appendix A).

Vanguard Investment Counseling & Research > 7

11 Social Security payments increase with inflation and come close to providing a consumption floor. However, if retiree expenditure patterns differ from those

used to compute consumer price inflation, Social Security benefits will not necessarily preserve living standards. A truly “guaranteed” level of income would

have to be indexed to the pattern of spending that a particular individual has every year. 
The purchaser of a variable annuity specifies the 

way the assets will be invested and agrees to an

“assumed interest rate,” or AIR. If the investments do

better than the assumed rate, the annuity payments

will rise proportionately; if the investments do worse

than the AIR, the payments will decrease. In this way

annuitants can take on as much or as little market risk

as they want, choosing stock investments for greater

risk or fixed income investments for less risk. The

annuity provider guarantees only that annuitants will

receive a payment as long as they live; it does not

guarantee the amounts of the payments. 

Figure 4 uses three hypothetical scenarios to show

how variable payments can evolve over 30 years. 

The scenarios are based on actual returns for the U.S.

stock market since 1962. In each case, an individual

uses $100,000 to purchase a variable annuity based

on the performance of the broad stock market and 

an AIR of 3.5%. One scenario starts in 1962, one in

1972, and the third in 1975. In all cases, the first

payment is exactly the same: $6,836. For the investor

starting in 1962, the smallest subsequent annual

annuity payment would have been $5,742, occurring

when he or she was 78 years old. Over the 30 years,

this investor’s annuity income would have averaged

$14,373 a year, with a standard deviation of $9,414.

For the investor starting in 1972, the smallest annual

payment would be $4,171, occurring at age 68; this

investor’s yearly payments average $26,299, with a

standard deviation of $23,681. As the data show, the

volatility of the payment stream is similar to that of

the overall stock market.

Regarding Figure 4, it’s worth noting that if the 1962

annuitant had instead invested the $100,000 in the

broad stock market and elected to take exactly the

same sequence of payments, he or she would have

spent all of the money after 21 years (at age 86). The

same would be true for the 1972 annuitant; for the

1975 annuitant, the money would have run out after

20 years (at age 85).

The unique promise of life annuities

The promise of guaranteed payments over a period 

of time is not unique to annuities. One can receive

guaranteed periodic payments from government

bonds, municipal bonds, or certificates of deposit, 

for example.

The feature that truly sets life annuities apart 

from alternative instruments is the promise that 

the payments will continue as long as one is alive. 

Life annuities are unique not because they promise

guaranteed returns (rate-of-return insurance), but

because they promise to last for a lifetime 

(longevity insurance). 

8 > Vanguard Investment Counseling & Research

Figure 4. Annual income from three hypothetical 

variable annuities starting at different dates, 

with payments based on stock market returns

0

40,000

80,000

120,000

$160,000

Annual payment amount

80 837774716865 86 89 91 95

Annuitant’s age

Start in 1962

Start in 1972

Start in 1975

Past performance is no guarantee of future returns. 

The performance of an index is not an exact 

representation of any particular investment, as you 

cannot invest directly in an index.

Notes: Each hypothetical annuity costs $100,000 and carries 

an assumed interest rate of 3.5%. Annuity payments are 

calculated according to the formula in Appendix A, assuming 

an annual insurance cost of 50 basis points. Market returns 

are represented by the Standard & Poor’s 500 Index through 

1970 and the Dow Jones Wilshire 5000 Total Market Index 

thereafter.

Source: Vanguard Investment Counseling & Research.
For the prospective annuitant, the question is 

whether this lifetime guarantee is worth its price. 

In the following section, we look at annuity 

costs and highlight aspects that any purchaser 

should consider.

Measuring annuity costs

In this section, we look at the cost of annuities from

several perspectives. We describe the different ways

insurers and purchasers estimate annuity value.

We look at ways to compare the cost of annuitization

with the cost of investing the same assets directly 

in an alternative portfolio. In addition, we discuss 

the impact of taxes and point out some less-tangible

considerations that purchasers should consider.

Although insurers provide some financial data, 

the fact that investment returns, administrative 

fees, and longevity forecasts interact to establish 

an annuity price can make it very hard to analyze 

the built-in costs. Because insurers generally do not

release detailed information on how actual longevity

experience compares with their original forecasts 

for annuitants, there is no way to know whether

systematic over- or underforecasting of mortality 

rates occurs. Systematic underforecasting would 

lead to higher expected revenues for the provider, 

and could thus be considered a cost or load;

systematic overforecasting would do the opposite. 

Because of these unknowns, it may be most useful 

to consider annuity costs from a different angle—

namely risk, an area in which the buyer may possess

information that the insurer does not have. At least 

in theory, prospective buyers can measure cost by

estimating what an annuity’s price should be for them

based on their best unbiased assessment of the risk

they actually face, and then comparing this estimate

with the insurer’s all-in price calculation. (This riskbased comparison will not, however, capture any

potential cost related to the loss of future liquidity;

such costs are more difficult to define and measure.)

A gap between the buyer’s estimate of the cost 

and the price the provider sets can arise from 

several sources. First among these could be any

explicit charges levied by the insurer. Such charges

include the mortality and expense (M&E) charges

intended to compensate the insurance company’s

owners for bearing the risks in the contract—in

particular, the nondiversifiable longevity risk. 

Typical M&E charges can be high, often above 

1% annually for a variable payout annuity.12

The second, but perhaps more significant, potential

cost to the buyer is the implicit one arising from

differences between how the buyer and the provider

assess risk. Such costs exist in all insurance markets,

because any risk may be assessed very differently by

an individual and an insurer. As a result of differences

in the perception of risk, a purchaser may see

insurance as overpriced (the insurer sees a greater

risk than the individual) or underpriced (the insurer

sees less risk than the individual).

This consideration leads to another potentially very

important factor in annuity pricing. It is reasonable 

to think that insurance for a particular risk is much

more valuable to those individuals who are aware

they have high exposure to that risk. If so, these

higher-risk individuals should be more likely to

purchase insurance (so long as prices can’t be 

fully adjusted to reflect all real differences in risk

exposure). This phenomenon is called adverse

selection. Several studies attempting to determine

whether adverse selection is important in annuity

pricing have concluded that this effect is present 

in annuity markets (see Brown, Mitchell, Poterba, 

and Warshawsky [2001]). This evidence suggests

annuities have higher cost for those people who 

have only an “average” or lower risk of living a 

long time. 

Vanguard Investment Counseling & Research > 9

12 As of January 31, 2008, the average M&E expense for variable-payout annuities was 1.19%, according to Morningstar, Inc.
’Money’s worth’ for annuities

The total cost, explicit plus implicit, can be estimated

by computing what is called a “money’s worth”

measure.13 A money’s-worth analysis measures total

annuity costs by comparing the prospective return

with what might be earned from a hypothetical costfree alternative. It shows the annuity’s value as a

fraction of the full present value of the costless

alternative. Thus, a money’s-worth ratio of 0.95, or

95%, indicates that the annuity has an implicit cost

equivalent to 5% of the initial purchase price. 

Several researchers have calculated estimates of

money’s-worth ratios for fixed income annuities

offered in the United States. Their estimates are

summarized in Table 1.

14 These data estimate 

present values of annuity payments relative to

average actual annuity prices, based on Treasury 

yield curves at the times of the studies (1995 and

1998) and an assumption about longevity patterns.

The data indicate, for example, that a 65-year-old 

male buying an immediate annuity in 1995 received

92.7 cents in present value for every dollar paid. By

1998, the ratio was substantially higher: A 65-year-old

male received 97.0 cents in present value for every

dollar paid.15

The fact that these numbers are less than 1 

does not mean that annuities are a “bad deal.” 

The calculation is based on a hypothetical cost-free

alternative; comparing this mythical product to a realworld annuity should be expected to produce a ratio

below 1. The issue is whether these money’s-worth

rates are too high or too low relative to available

substitutes. One way of making that judgment is 

to examine a similar money’s-worth measure for 

a hypothetical, but plausible, alternative spending

strategy that does not involve an annuity. Table 2

provides such estimates.16

10 > Vanguard Investment Counseling & Research

13 See Brown et al. (2001) for details.

14 These data pertain to companies listed in Best’s Review, which reports the results of an annual survey of insurers offering single-premium immediate annuities.

See Brown et al. (2001), Chapter 4, and Brown, Mitchell, and Poterba (2002) for details.

15 The assumptions used to price the “costless” annuity are critical. If an individual could obtain a guaranteed rate of return higher than that implied by the

Treasury yield curve, the money’s-worth ratio would be lower. Likewise, if the individual believed his or her longevity prospects were worse than those of the

population of individuals who have actually purchased annuities, the money’s-worth ratio would be lower. See Brown et al. (2001), Chapter 4, for details. 

16 We ignore taxes in this treatment. There may be different tax implications depending on the alternative investment strategy. We also ignore the fact that, by

spending at a rate that liquidates an investment over any set period, an investor always runs a risk of exhausting his or her assets before death. As discussed 

in detail previously, this risk can be decreased by extending the drawdown period significantly beyond life expectancy, but it cannot be eliminated. Although

annuities provide a guarantee against this risk, they also generally involve a loss of liquidity, which an alternative investment may not.

Table 1. ’Money’s worth’ calculations for fixed

income annuities purchased in 1995 and 1998, 

based on purchasers’ age

1995 1998

Men

55 0.934 0.970

65 0.927 0.970

75 0.913 0.966

Women

55 0.937 0.950

65 0.927 0.952

75 0.919 0.940

Source: Vanguard Investment Counseling & Research.

Table 2. ’Money’s worth’ calculations for payments

obtained by liquidating an alternative investment, 

with varying expense ratios

Annual expense charge

Years 0.25% 0.75% 1.25%

5 99.5% 98.6% 97.7%

10 99.0 97.1 95.2

15 98.6 95.7 92.8

20 98.1 94.4 90.8

25 97.7 93.3 88.9

30 97.4 92.3 87.3

Notes: The hypothetical investment is assumed to return 5% each year.

Payments are assumed to be level.

Source: Vanguard Investment Counseling & Research.
The data show that, if the alternative investment

involved annual expense charges of 0.25% and

provided a 5% yearly return (before expenses), 

an investor who liquidated the holding in equal

installments over ten years would receive 99% 

of what he or she would get if there were no cost 

at all. Relative to such a low-cost investment strategy,

even in 1998, annuities were significantly more

expensive. However, the picture is different for highercost alternative strategies: The same calculation

applied to a strategy with a 1.25% annual expense

charge (close to the actual 2007 industry average 

for retail mutual funds17) yields a money’s-worth 

ratio of 95.2% relative to a costless alternative. 

The higher the expenses, and longer the period used

to liquidate a portfolio, the lower the money’s-worth

value of the investment. For example, Table 2 shows

that liquidating a portfolio with expenses of 1.25%

evenly over a 20-year period has a money’s-worth

value of 90.8%. This is comparable to the level of cost

embedded in the typical annuity. The money’s-worth

ratio for withdrawing assets over 15 years (92.8%) is

almost identical to the money’s-worth ratio of a fixed

annuity in 1995 (92.7%). As shown in Figure 1, life

expectancy for a male 65-year-old retirement plan

participant is 17.5 years, which is between the 15- 

and 20-year spans. So the expected cost of pursuing

a systematic withdrawal strategy designed to exhaust

the investment at life expectancy, with expenses

roughly equivalent to what is charged by the average

mutual fund, is similar to the cost of pursuing the

annuity strategy. And in 1998, the cost of the

withdrawal strategy was actually slightly higher.

For retirees, these examples illustrate the importance

of comparing costs when considering any type of

investment. Annuity purchases always include some

insurance cost, while alternative investment strategies

may not. Over time, however, it’s easy to see that 

a high-cost investment may prove more expensive 

to own than a low-cost annuity, and of course, the

investment does not provide the insurance benefit 

of the annuity.

Illiquidity

One significant annuity cost that is not incorporated 

in the money’s-worth measure is loss of liquidity. 

In all current life annuity arrangements, annuitants

must irreversibly commit to leaving at least some

assets in the annuity pool. (Typically, the purchaser is

first given a brief “free look” period during which he

or she can decide to withdraw.) Some annuities do

offer what are called refund features, which have 

the potential to return some value to heirs upon an

annuitant’s death. Some providers also allow living

annuitants to get a portion of assets back if they have

bought a refund option. However, the principle that

allows annuities to operate—the implicit transfer of

assets from those who die sooner than expected to

those who die later—requires that some assets be

left in the pool permanently by those whose lives are

relatively short. This means that commitments must

be firm.

The loss of flexibility that annuities require can

represent a significant cost to investors who wish to

maintain liquidity. Unfortunately, the cost of illiquidity

cannot be easily assessed, and will vary by investor

and wealth level.

Provider risk

The existence of provider risk is not a direct 

cost of annuities, of course. However, the risk is

something that all prospective purchasers should be

aware of, and it thus has a bearing on the way they

will assess an annuity’s value. (While annuities are

subject to provider risk, an alternative investment 

may be subject to investment risk.) The guarantees

embedded in an annuity contract are conditional on

the financial strength of the annuity provider. The

financial status of insurance providers is regularly

reviewed and analyzed by regulators, and is further

monitored by ratings agencies such as Moody’s

Investors Service, Standard & Poor’s, and A.M. 

Best. Nonetheless, there is always some risk that 

an insurance company will fail and its policyholders

will face a reduction in annuity payments. Large

insurance company failures have been extremely 

Vanguard Investment Counseling & Research > 11

17 1.22% in 2007, according to Lipper Inc.
rare, but have occurred. For example, after California

regulators took control of Executive Life in 1991, 44,000

retirees received only 70 percent of their promised

annuity payments for a period of 13 months.18

Insurance companies are regulated at the state level,

and all 50 states have guaranty laws and a guaranty

association fund designed to protect policyholders 

if an insurer becomes insolvent.19 In most states,

these guaranty funds protect the present value of

policyholder contracts up to $100,000 (and in some

cases $300,000). However, the rules regarding

eligibility for payment from guaranty funds vary from

state to state, and the payments can be subject to

significant administrative delays. 

Taxes

Income tax treatment can have a significant impact on

the attractiveness of annuity payments as a source of

income in retirement. The tax code can put annuities

at a disadvantage relative to other means of drawing

from assets for several reasons.

Generally speaking, annuity payments are subject to

income tax. If an annuity is purchased with taxable

assets, rules in the tax code dictate the amount of

each payment that will be subject to taxation. In

general, the intent of these rules is to allow the

annuity’s purchase price to be returned, tax-free, to

the annuitant in roughly equal installments over his 

or her life expectancy. The amounts in excess of this

“return of capital” are taxed as income in the year

they are received. Should the retiree live long enough

to recover the entire cost of the annuity, subsequent

payments are 100% taxable as income.

This treatment can place after-tax income 

annuities at a disadvantage relative to other 

forms of distributions in taxable accounts. The 

primary reason is that income tax rates are typically

higher than capital gains tax rates. For example, an

individual who invests assets in a stock mutual fund

will pay capital gains tax rates on the long-term gains

realized by the fund, on qualifying dividends, and on

any price gains for fund shares held longer than one

year before being sold. If that individual instead

12 > Vanguard Investment Counseling & Research

18 Residents of a few states received reduced payments for a longer period. See U.S. General Accounting Office (1993).

19 These guaranty association funds are not backed by the state nor are they part of the state government. The funds are supported collectively by contributions

from insurers operating in each state.

Alternatives to commercial annuities

Several alternatives promising annuity-like 

income exist, including charitable gift annuities,

charitable remainder annuity trusts, charitable

remainder unitrusts, and private annuities. 

Historically, such arrangements have been 

used primarily by wealthy individuals whose 

objective is a tax-efficient transfer of assets 

out of their estates to heirs or worthy causes. 

These types of arrangements can be very useful,

especially for those holding assets with significant

unrealized capital gains, as they generally make it

possible to avoid both capital gains taxes and estate

taxes on the assets that are employed. However, if 

a retiree is mainly concerned not with estate issues

but with maintaining a long-term source of income,

the creditworthiness of the annuity provider is of

heightened importance. As mentioned earlier,

insurance companies can credibly make annuity

promises in part because they serve large numbers 

of annuitants and can confidently project mortality

patterns within the pool. Other entities may lack 

such a large pool of annuitants, and therefore 

possess no reliable way to forecast revenues or

liabilities. As a result, the payment promises from

these entities can be significantly more risky. While

there are a variety of ways for providers to handle

such risks, detailed disclosure of their financing

methods often is not available, and regulatory

supervision of such entities may not be as 

thorough as it is for commercial insurers.
invests the assets in an annuity, income taxes will 

be due on all forms of return (above the annuity’s

purchase price). As of 2008, long-term capital gains

are taxed at 15%, while income tax rates range up 

to 35%, so this can represent a significant cost.

For annuities purchased using pre-tax amounts in

either a qualified retirement plan or a traditional 

IRA, 100% of all payments are taxed as income.20

This treatment is not unique to annuities; the same

would be true for any other distribution of such taxdeferred assets. The question here is whether, absent

an annuity, an individual might have been able to pay

less in taxes while still meeting spending goals by

relying on required minimum distributions (RMDs)

from the tax-deferred accounts. Even if tax-deferred

assets are used to purchase an annuity, RMDs still

must be taken from any remaining money in the

accounts. The combination of taxable annuity income

and taxable RMDs may result in more tax owed 

than would have been the case if the individual 

relied solely on RMDs. 

Finally, a few states levy a “premium tax” on

amounts used to purchase income annuities. 

Key considerations regarding

annuity costs and risks

Investors contemplating an annuity purchase 

should of course review the cost and fee information

provided by the insurance company. They should

make sure they understand how these stated

expenses will apply to the purchase amount and 

also to the promised future payments. In addition,

investors should be aware of less-obvious costs 

and risks, and should evaluate their impact as far 

as possible. 

Chief among these less-obvious factors are illiquidity,

provider risk, and taxes. The first two can be assessed

only in individual terms, with each investor making a

personal decision about their importance. The impact

of the third factor—taxes—can be measured to an

extent, perhaps with the assistance of a financial

advisor or tax professional. 

In the next section, we report on our use of financial

simulations to look at the tradeoffs involved in the

selection of various retirement income strategies.

Analysis of the financial consequences 

of annuitization: Benchmark simulation

To help prospective purchasers understand the 

costs and benefits of annuitization, we conducted 

a simulation analysis to see how owning an annuity

might help—or hinder—an investor under various

circumstances in an extended retirement. In this

section we describe some of the key results.

The analysis compared two income strategies

incorporating annuities with a strategy based on

simply withdrawing money from a mutual fund

portfolio. These strategies were tested in 5,000

scenarios employing simulated market data and

inflation rates. The two annuity strategies differ 

solely in the source of the assets used to purchase

the annuities. One strategy uses taxable assets for

the purchase; the other uses tax-deferred assets.

Our broad assumptions were as follows:

• In all scenarios, we assume the investor is an

individual entering retirement with $1,000,000 

in assets, divided equally between taxable and 

tax-deferred accounts. (For ease of discussion 

we will assume this investor is male; quantitative

results would differ for females as annuity

payments and life expectancies differ.)

• The retiree wants to spend $45,000 a year,

adjusted for inflation, for the rest of his life. 

• In the annuity scenarios, the retiree uses 50% 

of his assets to buy two annuities (one fixed, 

the other variable) and holds the remainder in 

a diversified investment portfolio. We do not

endorse or recommend 50% as an optimal

fraction; we merely use 50% to illustrate the

impact of a substantial level of annuitization. 

Our simulation assumes that 35% of the 

annuity allocation goes to the fixed income 

annuity and 65% to the variable annuity.

Vanguard Investment Counseling & Research > 13

20 Withdrawals taken from a tax-deferred annuity before the investor reaches age 591⁄2 may be subject to both ordinary income tax and a 10% federal 

penalty tax.
• For both his mutual fund holdings and his overall

portfolio including the income annuity, the retiree’s

investment allocation is 70% fixed income and

30% stocks—a typical “income-oriented” portfolio.

We assume that 20% of the total unannuitized

portfolio return in each year is in the form of

realized short-term capital gains.

• The analysis assumes that there are no 

investment management costs (though the 

relative comparison of the strategies would 

still be valid if investment-related costs are 

equal for both unannuitized and annuitized 

wealth). For the variable-annuity scenarios, 

we assume that insurance-company charges

reduce the returns credited to the retiree by 

50 basis points (0.5 percentage point) a year. 

In the case of the fixed annuity, we assume

insurance charges are embedded in the 

annuity payout. 

Full details of our assumptions and results are

provided in Appendix B, along with more extensive

discussion of specific findings. 

Drawing from the results of the analysis, Figure 5

illustrates success rates for a hypothetical 70-yearold who desires to meet annual expenses of $45,000,

adjusted for inflation, over 30 years starting in 2007.

We show the success rates under three circumstances:

(1) The investor has no annuity; (2) the investor buys

an annuity using tax-deferred assets; (3) the investor

buys an annuity using taxable assets. 

In each case, the success rates are above 99% until

after the investor reaches age 85. Once that age is

reached, however, the success rates fall much faster

if the investor has not bought an annuity. At age 95,

the investor has only a 64% chance of meeting the

spending target without an annuity; with an annuity,

the chance is 89% or even higher. This same pattern

holds for an investor who starts at age 65 and one

who starts at 75 (see Appendix B). 

14 > Vanguard Investment Counseling & Research

Figure 5. Rates of success at meeting required 

expenses over 30 years, starting at age 70 

(benchmark simulation)

0

20

40

60

80

100

120%

Probability of success

70 75 80 85 90 95 99

Investor’s age

No annuity

Annuity purchased with tax-deferred assets

Annuity purchased with taxable assets

Note: The annuity investment is assumed to be 35% in 

a fixed-payment annuity and 65% in a variable annuity. 

See Appendix B for details of the benchmark simulation 

assumptions.

Source: Vanguard Investment Counseling & Research.
When the retiree’s income falls short of the $45,000

spending goal, how far short is it? Figure 6 shows 

the answer to that question for a retiree starting at

age 70, displaying the average shortfall at four ages

under each of the same three circumstances. The

existence of an annuity clearly cushions the annuitant

in those circumstances when money is exhausted in

an unannuitized portfolio.

Figure 7 illustrates another aspect of the annuity

decision: the potential effect on the investor’s estate.

If the investor buys an annuity at age 70 and dies

within ten years, the estate will be much smaller 

than if there were no annuity. However, if the same

investor survives to age 90 or beyond, the estate 

will be greater with the annuity, according to our

analysis. The reason is that, in the intervening years,

an investor who lacked annuity income would have 

had to draw down the portfolio more rapidly to 

meet spending needs. 

Vanguard Investment Counseling & Research > 15

Figure 6. Degrees of shortfall in cases when 

spending goals are not met (benchmark simulation) Average shortfall

85 90 95 99

Investor’s age

No annuity

Annuity purchased with tax-deferred assets

Annuity purchased with taxable assets

Note: See Appendix B for details of the benchmark 

simulation assumptions. At age 85, there is no shortfall 

for an annuity purchased with tax-deferred assets.

Source: Vanguard Investment Counseling & Research.

–50,000

–40,000

–30,000

–20,000

–10,000

$0

Figure 7. Year-end estate levels at various ages 

(benchmark simulation)

0

200,000

400,000

600,000

800,000

$1,000,000

Estate

70 80 90 99

Investor’s age

No annuity

Annuity purchased with tax-deferred assets

Annuity purchased with taxable assets

Note: See Appendix B for details of the benchmark 

simulation assumptions.

Source: Vanguard Investment Counseling & Research.
In summary, several points should be made about the

data in these tables: 

• In all cases, the presence of income annuities

significantly increases the average level of taxable

income that a retiree receives in retirement, while

significantly reducing the average level of liquid

(and bequeathable) wealth in early retirement.

• In all cases, in circumstances where the

unannuitized portfolio ends up exhausted at some

point, spending shortfalls are significantly lower

when the annuity is present. At most ages when

portfolio assets are exhausted but an annuity 

is present, the shortfalls are at least 35% lower

than when no annuity is present.

• “Bequest breakeven” points (the age at which 

the annuity cost is fully recovered, in the sense

that the average estate of an annuity buyer is at

least as large as that of a nonbuyer) are highly

dependent on the age at which an annuity is

started and other assumptions. In these analyses,

it is approximately between ages 80 and 85. A

clear cost of annuitization is the lower level of

liquid, bequeathable wealth that the retiree 

would hold at least until reaching the age of his

theoretical life expectancy. 

• Whether it is better to use taxable or tax-deferred

assets for the annuity purchase depends on the

individual tax parameters and on what “better”

means to the investor. In most of the simulated

situations we examined, buying annuities with 

tax-deferred assets appeared to produce better

outcomes than buying annuities with taxable assets.

However, certain assumptions we used may have

influenced this result. For a fuller discussion of the

factors involved, see Appendix B.

Overall, the analysis indicates that, for retirees who

are willing to give up liquidity and reduce bequeathable

assets (initially) in order to anticipate higher sustainable

income upon reaching their 90s, income annuities can

efficiently achieve the objective.

Other simulations

Under the previous assumptions, which we refer to 

as benchmark simulation, the annuitant purchased

two annuities—one fixed, the other variable. In

practice, the vast majority of life annuities people buy

are fixed annuities. Therefore, we here look at a case

in which the investor uses 50% of his assets to buy 

a simple fixed annuity, providing a constant lifetime

payment. We label this as Scenario 2. 

We also looked at a revised spending assumption. 

In the benchmark simulation, we assumed constant

spending of $45,000 a year, adjusted for inflation. 

In practice, many retirees may be content to allow

their baseline spending to fall slightly in inflationadjusted terms as retirement goes on. However,

investors also may face large, unexpected medical

expenses in retirement (primarily as a result of longterm care needs). To illustrate the potential impact of

such patterns of behavior and experience, we created

a scenario in which inflation-adjusted spending starts 

at $45,000 and decreases by 1% annually in the first

nine years of retirement; then, in the tenth year, the

retiree experiences a health shock that leads to a

permanent doubling of real spending. We call this

Scenario 3.

Figure 8a and Figure 8b, on page 17, show the

average estate balance at various ages for someone

who starts at age 70 under Scenarios 2 and 3. In 

each case—as was also true in the benchmark

simulation—estates are higher in the early years for 

a nonannuitized portfolio, but that picture changes 

at later ages. Again the reason is that a retiree who

lacks an annuity will have to draw down his portfolio

at a faster rate to meet spending needs in later years. 

Scenario 2 features one distinctive difference from 

the benchmark simulation: For the investor with an

annuity, the estate increases noticeably between

ages 70 and 80. This occurs because the fixed 

annuity produces a higher payment in the early 

years than was true in the benchmark simulation. 

In Scenario 3, with spending levels decreasing 

during the early years, the estate is predictably 

larger early on; however, that advantage is erased

when the health shock occurs in the tenth year.

16 > Vanguard Investment Counseling & Research
The higher payments early on in Scenario 2 

illustrate a primary factor that attracts purchasers 

to fixed annuities. Under the benchmark simulation,

with the annuity investment divided between fixed

and variable annuities, the 70-year-old retiree’s firstyear annuity payment is $46,124. Under Scenario 2, 

the first-year payment is $49,193, giving him about

$3,000 above his spending goal, money that can be

saved each year to augment his estate. This higher

level of income in early years can be a persuasive

psychological and practical factor for people who 

are reluctant to buy an annuity in the first place. 

However, if the true goal is to insure against 

longevity risk and provide for real income at 

advanced ages, annuitants should take a broader

view. Specifically, they should keep in mind both 

the erosive power of inflation and the potential 

for higher market returns. As time progresses, 

the value of constant payments will be eroded 

by inflation; meanwhile, the investor will lack any

exposure to the potentially higher returns from 

stocks that a variable annuity could provide. In

addition, the higher annuity income in the early 

years would have increased taxable income, 

creating an additional drag. To make these 

concerns concrete, consider our results for the 

70-year-old investor who purchases a fixed annuity

with tax-deferred assets: By the time he reaches 

age 99, his success rate for meeting the spending

target is about 86% under Scenario 2, compared 

with 91% under the benchmark simulation.

See Appendix B for a more detailed discussion of

Scenario 3, including a close look at cases in which

the spending target is not met.

Vanguard Investment Counseling & Research > 17

Figures 8a and 8b. Year-end estate levels at various ages

Scenario 2: 100% of annuity investment is a 

fixed-payment option 

Scenario 3: Same portfolio as in baseline case; goal declines 

each year; a medical shock occurs in the tenth year

No annuity Annuity purchased with tax-deferred assets Annuity purchased with taxable assets

Note: Assumptions are the same as for the benchmark simulation, except as noted. See Appendix B for details of the benchmark simulation 

assumptions.

Source: Vanguard Investment Counseling & Research.

0

200,000

400,000

600,000

800,000

$1,000,000

Estate

70 80 90 99

Investor’s age

0

200,000

400,000

600,000

800,000

$1,000,000

Estate

70 80 90 99

Investor’s age
Conclusions

Income annuities offer retirees a direct method 

for reducing the significant longevity risk they 

face. The costs of annuitization arise from 

several sources: explicit and implicit insurance 

costs, the loss of investment liquidity, a reduction 

in bequeathable wealth, and potentially unfavorable

tax treatment. Insurance and investment costs can 

be quickly assessed using a single money’s-worth

measure, which reveals that average annuity costs 

are significant but comparable to those of mutual

funds with industry-average expenses. Just as 

low-cost mutual funds can significantly reduce

investment expenses, low-fee annuities present 

an opportunity to obtain the insurance provided 

by an annuity at a better price. 

For those who place a significant weight on

maintaining spending levels late in retirement (into

their 90s and beyond) and are willing to accept the

costs and risks of annuitization in the near term,

financial simulations suggest that low-cost income

annuities can be of value as a part of a broader

investment and spending plan.

References 

Ameriks John, Robert Veres, and Mark J. Warshawsky,

2001. Making Retirement Income Last a Lifetime.

Journal of Financial Planning (December); http://

www.fpanet.org/journal/articles/2001_Issues/

jfp1201-art6.cfm

Bengen, William P., 1994. Determining Withdrawal

Rates Using Historical Data. Journal of Financial

Planning (October); http://www.fpanet.org/journal/

articles/2004_Issues/jfp0304-art8.cfm

Bengen, William P., 1997. Conserving Client Portfolios

During Retirement, Part III. Journal of Financial

Planning (December); http://www.fpanet.org/journal/

articles/1997_Issues/jfp1297-art12.cfm

Best’s Review. http://www.bestreview.com.

Brown, Jeffrey R., Olivia S. Mitchell, and James M.

Poterba, 2002. Mortality Risk, Inflation Risk, and

Annuity Products. In Innovations in Retirement

Financing, edited by Olivia S. Mitchell, Zvi Bodie, P.

Brett Hammond, and Stephen Zeldes. Philadelphia:

University of Pennsylvania Press.

Brown, Jeffrey R., Olivia S. Mitchell, James M.

Poterba, and Mark J. Warshawsky, 2001. The 

Role of Annuity Markets in Financing Retirement.

Cambridge, Mass.: MIT Press.

Davidoff, Thomas, Jeffery R. Brown, and Peter A.

Diamond, 2005. Annuities and Individual Welfare.

American Economic Review 95(5):1573–1590.

Huang, Huaxiong., M.A. Milevsky, and Jin Wang,

2004. Ruined Moments in Your Life: How Good 

Are the Approximations? Individual Finance 

and Insurance Decisions Centre working paper, 

February; http://www.ifid.ca/pdf_workingpapers/

WP2004FEB28.pdf.

Korenman, Sanders, Noreen Goldman, and 

Haishan Fu, 1997. Misclassification Bias in 

Estimates of Bereavement Effects. American 

Journal of Epidemiology 145(11):995–1002.

Kotlikoff, Laurence J., and Avia Spivak, 1981. 

The Family as an Incomplete Annuities Market.

Journal of Political Economy 89(2, April):372–391.

Milevsky, Moshe A., and Kamphol Panyagometh,

2001. Variable annuities versus mutual funds: 

a Monte-Carlo analysis of the options. Financial

Services Review 10; http://www.yorku.ca/milevsky/

Papers/FSR2002B.pdf.

Pye, Gordon B., 2000. Sustainable Investment

Withdrawals. Journal of Portfolio Management

(Summer):73–83.

Samuelson, Paul A., 1963. Risk and Uncertainty: A

Fallacy of Large Numbers. Scientia (April/May):1–6.

Society of Actuaries (SOA). The RP-2000 

Mortality Tables; http://www.soa.org/files/pdf/

rp00_mortalitytables.pdf. 

U.S. General Accounting Office, 1993. Private

Pensions: Protections for Retirees’ Insurance

Annuities Can Be Strengthened. Report to Congress.

Washington, D.C.: GAO; http://archive.gao.gov/

d45t15/148994.pdf.

Yaari, Menahem E., 1965. Uncertain Lifetime, 

Life Insurance, and the Theory of the Consumer.

Review of Economic Studies 32(2):137–150.

18 > Vanguard Investment Counseling & Research
Appendix A. Annuity pricing and 

payment formulas

Annuity pricing

Annuity pricing can be summarized via a

mathematical formula: 

where at is the annuity price at time t, ct is the

payment due in time t, pt is the probability that 

the annuitant(s) will survive to period t, rt is the 

net rate of return, or discount rate, from period 

t–1 to t, and T denotes the longest possible lifespan.

Often insurers will set annuity prices assuming a

constant discount rate, although some will use a

complete term structure of interest rates in these

calculations, effectively discounting payments over

time at a date-specific rate, as in the formula above.

Note that this differs from a present-value calculation

only by the presence of the pt terms. Note also that

the first payment is assumed to be ct, meaning that

the first annuity payment comes in the same period

as the purchase of the annuity.

Although the most typical form of life annuity involves

a sequence of fixed payments for life, there is nothing

in the definition of an annuity that requires constant

fixed payments; all that is needed is a stated rule that

will determine the payments to be made in each year.

In other words, a stream of payments that increases

or decreases by 3% per year is still an annuity, as is 

a payment that is scheduled to rise by 1%, then fall

by 2%, then rise by 3%, etc. Any such pattern is

theoretically possible. 

The variable annuity payment formula

Calculating payments in a variable income annuity 

is quite simple. For the initial payment, the insurer

does a standard annuity price calculation, assuming

level payments, using an assumed rate of return

(often selected by the annuitant) for discounting the

payments, and the insurer’s longevity expectations.

The calculation uses the same formula listed above

for fixed annuities. 

The initial payment is made to each annuitant based

on this calculation. But then, each year going forward,

payments to all living annuitants change according to

the following rule:

New payment = Previous payment x (1 + realized 

rate of return – fees and charges) / (1 + assumed 

rate of return)

The formula works as follows (assuming fees of 

1%): If the investments chosen by the annuitant

return 8%, and the assumed rate was 3%, the new

payment would equal (1.08–0.01 ) ÷ 1.03 = 1.0388

times the old payment, meaning it would rise by

about 4%. If, instead, realized returns were –5%, 

then the new payment would equal (0.95–0.01) ÷

1.03 = 0.913 times the old payment, meaning it 

would fall by around 9%. Payments are then made 

at the new level until the end of the next year, 

when the level may change again based on realized

performance. The formula automatically reduces

payments in years when investments don’t generate

the assumed return, and increases them in years

when returns are higher than the assumed rate.1

While it is typical that payment adjustments will 

occur annually, insurers often allow adjustments 

in the payment size to be made more frequently.

The formula implies that no matter how long an

annuitant lives, income payments will rise or fall 

each year according to how selected investments

perform relative to the assumed net rate of return. 

It is important to note that the computed value (at) 

of the payment stream is the same regardless of

what assumed rate of return is used; the assumed

rate simply affects the pattern of payments over time. 

Vanguard Investment Counseling & Research > 19

1 It is important to note that the initial payment is set assuming that future returns will equal the assumed rate. In a sense, the annuitant gets an “advance credit”

for that rate of return in the initial payment and each subsequent one. 

at = ct + pt+1 1+r ( ) t+1

ct+1 + pt+2 1+r ( ) t+1 1+r ( ) t+2ct+2

+ . . . + pT 1+r ( ) t+1 1+r ( ) t+2

cT

. . . 1+r ( ) T
Appendix B. Benchmark simulations and further discussion

20 > Vanguard Investment Counseling & Research

Tables 3a–c. Income and spending levels with and without annuities (benchmark simulation)

3a. For an investor starting at age 65

Income/ Taxable Tax-deferred Estate at Success Average Conditional

Age expense portfolio portfolio year-end rate shortfall shortfall

No annuity

65 0.35 $470,259 $521,154 $845,489 1.00 — —

70 0.59 306,061 601,558 739,182 1.00 — —

75 0.56 193,354 592,010 619,601 1.00 — —

80 0.54 104,210 533,256 488,154 0.99 $ 20 $25,443 

85 0.49 64,092 388,602 343,886 0.93 2,538 35,748 

90 0.38 49,731 225,618 212,176 0.67 13,656 41,182 

94 0.29 44,737 127,418 136,478 0.45 23,766 42,946 

Annuity purchased with tax-deferred assets

65 1.05 $502,163 — $502,163 1.00 — —

70 1.06 494,117 — 494,117 1.00 — —

75 1.04 482,003 — 482,003 1.00 — —

80 1.04 471,046 — 471,046 0.99 $ 8 $18,961 

85 1.05 464,418 — 464,418 0.98 406 20,309 

90 0.97 446,324 — 446,324 0.92 1,907 23,149 

94 0.99 442,169 — 442,169 0.84 3,608 22,521 

Annuity purchased with taxable assets

65 0.67 — $500,539 $360,388 1.00 — —

70 0.94 $ 1,749 484,160 350,345 1.00 — —

75 0.98 15,995 442,091 334,301 1.00 — —

80 1.01 39,819 384,379 316,572 0.98 $ 332 $18,855 

85 1.06 76,421 315,979 303,926 0.90 2,098 21,230 

90 1.03 115,786 236,827 286,301 0.77 5,166 22,716 

94 1.06 156,350 175,229 282,515 0.68 6,986 22,066 

See table note, assumptions, and explanations of column labels on page 23.
Vanguard Investment Counseling & Research > 21

3b. For an investor starting at age 70

Income/ Taxable Tax-deferred Estate at Success Average Conditional

Age expense portfolio portfolio year-end rate shortfall shortfall

No annuity

70 0.64 $483,434 $503,412 $845,891 1.00 — —

75 0.64 383,141 495,216 739,697 1.00 — —

80 0.61 279,540 467,179 615,909 1.00 — —

85 0.59 183,058 409,926 478,205 0.99 $ 23 $22,768 

90 0.52 120,688 286,727 327,132 0.92 2,903 35,574 

95 0.37 86,762 147,508 192,968 0.64 14,928 41,214 

99 0.25 68,654 69,404 118,624 0.41 25,514 42,953 

Annuity purchased with tax-deferred assets

70 1.12 $505,765 — $505,765 1.00 — —

75 1.16 517,668 — 517,668 1.00 — —

80 1.16 529,065 — 529,065 1.00 — —

85 1.19 546,360 — 546,360 1.00 — — 

90 1.14 558,653 — 558,653 0.995 $ 93 $19,279 

95 1.17 576,864 — 576,864 0.96 742 21,084 

99 1.22 603,129 — 603,129 0.93 1,498 20,583 

Annuity purchased with taxable assets

70 1.03 $ 1,385 $503,406 $363,837 1.00 — —

75 1.09 20,607 489,636 373,145 1.00 — —

80 1.16 56,022 450,269 380,215 1.00 — —

85 1.24 108,372 391,135 389,990 0.99 $ 73 $16,664 

90 1.25 169,404 309,743 392,419 0.96 899 20,918 

95 1.30 245,285 215,202 400,230 0.89 2,299 20,787 

99 1.33 313,971 141,558 415,892 0.82 3,551 20,153 

See table note, assumptions, and explanations of column labels on page 23.
22 > Vanguard Investment Counseling & Research

3c. For an investor starting at age 75

Income/ Taxable Tax-deferred Estate at Success Average Conditional

Age expense portfolio portfolio year-end rate shortfall shortfall

No annuity

75 0.69 $ 486,016 $499,926 $ 845,962 1.00 — —

80 0.71 400,617 471,106 739,813 1.00 — —

85 0.69 314,250 418,235 615,380 1.00 — —

90 0.67 231,164 339,709 475,755 0.99 $ 24 $24,071 

95 0.56 166,431 215,278 321,431 0.91 3,068 35,432 

100 0.37 118,357 92,819 185,187 0.62 15,544 41,274 

104 0.21 86,567 33,989 111,039 0.38 26,491 42,811 

Annuity purchased with tax-deferred assets

75 1.38 $ 517,351 — $ 517,351 1.00 — — 

80 1.45 590,131 — 590,131 1.00 — — 

85 1.49 668,655 — 668,655 1.00 — — 

90 1.40 738,833 — 738,833 1.00 — — 

95 1.49 814,757 — 814,757 1.00 — — 

100 1.59 910,484 — 910,484 0.99 $ 36 $22,298 

104 1.71 1,006,981 — 1,006,981 1.00 90 17,943 

Annuity purchased with taxable assets

75 1.33 $ 15,048 $499,926 $ 374,995 1.00 — —

80 1.44 103,293 471,100 442,485 1.00 — —

85 1.56 212,129 418,199 513,232 1.00 — —

90 1.53 324,298 344,344 572,226 1.00 — —

95 1.65 449,497 251,891 630,858 0.99 $ 23 $16,714 

100 1.72 593,214 151,481 702,280 0.99 157 20,122 

104 1.75 713,587 82,495 772,984 0.98 417 18,432

See table note, assumptions, and explanations of column labels on page 23.
Assumptions and explanations with Tables 3a, 3b, and 3c

Notes: With one exception, all data in Tables 3a, 3b, and 3c are averages over 5,000 simulations at each age. The exception is the conditional shortfall results, which

are averages over only those simulations in which portfolio assets are exhausted. All monetary figures are in inflation-adjusted dollars.

Assumptions 

• The starting portfolio is $1,000,000, of which $500,000 is held in a taxable account and $500,000 in a tax-deferred account. The cost basis for the taxable account 

is $400,000.

• In the annuity scenarios, 50% of the investor’s portfolio goes to the annuity purchase. Of the amount spent, 35% is used to buy a guaranteed, fixed annuity 

with payments that increase by 3% per year. The remaining 65% buys a variable annuity with a 3.5% assumed interest rate (AIR). The annuity rates are based 

on quotes obtained from Vanguard.com on January 2, 2008; see Appendix D.

• The spending goal is $45,000 each year, adjusted for inflation. Asset returns are from a portfolio of 70% bonds and 30% stocks, which is rebalanced without cost

each year. In the annuity scenarios, the underlying combined portfolio for the fixed and variable annuities is allocated and rebalanced in the same way, assuming

that the fixed annuity is invested 100% in bonds and the variable annuity is invested 54% in bonds and 46% in stocks.

• Of each year’s total portfolio return, 20% is in the form of realized short-term capital gains. When gains are realized from taxable holdings, we assume that the

appropriate tax is paid.

• Annuity income is from a single life annuity for a male annuitant in Pennsylvania with a birthday of January 2. The first annuity payment will come a year later, 

on January 1, 2009; see Appendix D.

• The variable annuity is assumed to carry insurance fees of 50 basis points annually. Otherwise, no investment costs are assumed.

• Tax rates used are 28% for income tax and 15% for capital gains and dividends. Annuity payments from after-tax sources are taxed according to the general 

rule. For tax-deferred assets, the IRS required minimum distribution (RMD) table is followed. Distributions begin in the year when the investor turns 701

⁄2.

• When drawing from the nonannuitized assets, the investor uses the taxable account first. Once taxable assets are depleted, the investor uses the taxdeferred account.

• See Appendix C for details of our assumptions about median market rates of return and inflation rates.

Explanations of column labels

Income/expense: The average of the ratio of the year’s overall income from all sources (including RMDs) to the total spending level. A number greater than one

indicates that the average amount of income (interest and dividend income plus RMDs, if any, and annuity payments, if any) exceeds the $45,000 spending level 

used in the analysis, while a number less than one indicates that assets must be sold at that age to meet the spending target.

Taxable portfolio: The average balance of the taxable portfolio at each year-end.

Tax-deferred portfolio: The average balance of the tax-deferred portfolio at each year-end.

Estate at year-end: The average after-tax value of an investor’s estate, should death occur that year. We assume that the heirs immediately liquidate the 

tax-deferred account, which incurs an income tax levy. In reality, the heirs can decide to retain the tax-deferred account so long as they take RMDs according 

to the existing schedule.

Success rate: The fraction of the 5,000 simulations in which the portfolio is not exhausted at that point in time. (If the success rate is between 0.99 and 1, it is

rounded down to 0.99.)

Average shortfall: The average amount, if any, by which income falls short of the desired spending level ($45,000 annually, adjusted for inflation) across all

simulations. (In scenarios where there is no shortfall, a zero is recorded and included in this average.)

Conditional shortfall: Looking only at those simulations in which the portfolio has been exhausted, this column shows the average amount by which income 

falls short of the desired spending level in that year.

Important: The projections or other information generated regarding the likelihood of various investment outcomes are hypothetical in 

nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary with each use and over time.

Source: Vanguard Investment Counseling & Research.

Vanguard Investment Counseling & Research > 23
Our analysis compared a distribution strategy based

solely on the liquidation of a mutual fund holding 

with strategies that involve the use of a low-cost

income annuity as well. The analysis uses 5,000

simulated scenarios of returns on stock, bond, 

and cash investments as well as projected inflation

rates for the next 30 years. It takes into account 

tax treatment and the existence of RMD rules for 

tax-deferred assets, as well as the insurance cost 

of annuitization.

The data in tables are averages over the 5,000

scenarios. Most of our assumptions for the scenarios

are listed on page 23. The median simulated total

returns and standard deviations are reported in

Appendix C. The actual annuity quotes we used and

their source are shown in Appendix D. 

Below is some further discussion concerning aspects

of our findings that are mentioned in the main text of

the paper.

Considerations regarding the purchase of an

annuity with taxable versus tax-deferred assets

In these scenarios, in which the investor’s taxable

account has an initial cost basis of 80% (20% of 

the taxable portfolio is unrealized capital gains), the

use of tax-deferred rather than taxable assets for

annuitization generally produces higher estate values

and higher probabilities of success at later ages. 

For an investor whose after-tax portfolio has a 

higher cost basis than we assume, or whose taxable

portfolio is particularly tax-inefficient, it may be more

attractive to use taxable assets for annuitization. In

addition, the relative attractiveness of using taxable 

or tax-deferred assets for annuitization depends

heavily on our assumption that money left in taxdeferred accounts is subject to immediate income

taxation upon death, while taxable accounts receive 

a step-up of cost basis (i.e., no tax is due) at death.

With proper estate planning, bequeathed tax-deferred

accounts may not produce a large immediate tax bill,

but instead may be distributed slowly over the lifetime

of beneficiaries at a lower tax cost. Examination of

the particulars of estate planning scenarios goes

significantly beyond the scope of this analysis; but 

we acknowledge that estate planning may materially

alter the attractiveness of using tax-deferred assets

for annuitization.

Further observations regarding the effect of a 

’health shock’ ten years into retirement

Figure 8b on page 17 shows the results of simulations

assuming that an investor suffers an adverse health

event after ten years (Scenario 3). We assumed that

this health shock required a doubling of real spending

starting at that point.

It is notable that in these simulations, the estates are

all near exhaustion by the time the investor reaches

age 90, regardless of whether he owns an annuity or

not. Once he reaches age 99, he has a 12% chance

of meeting the spending goal if he owns an annuity

bought with tax-deferred assets, but just 1% if he

owns no annuity at all. If the individual dies at 99, the

average estate is $33,347 with an annuity and $1,519

without one. The situation is slightly better when

annuity payments start at age 75, in part because the

payments would be higher if they started at a later

age. Should the investor reach age 100, he would

have a 53% chance of meeting the spending goal if

he owned an annuity bought with tax-deferred assets,

as compared to 3% without any annuity. If he died at

age 100, the expected estate is $202,901 with the

annuity, compared with $6,523 absent any annuity. 

24 > Vanguard Investment Counseling & Research
The exhaustion of estates at advanced ages in

Scenario 3 indicates that in the presence of a health

shock, the benefit of an annuity is solely to provide

some income. In this scenario, both the expected 

and conditional spending shortfalls are much smaller 

if there is an annuity present, as shown in Figures 9a

and 9b. Thus in a sense, the annuity provides a form

of insurance that can help to pay for continuing

medical bills. However, it will not effectively protect

the estate when there is a health shock at such a 

late age. And if the health shock had instead occurred

when the individual was young, an annuity purchase

would have radically reduced the estate while offering

little prospect for recouping the price through income

payments, given the buyer’s reduced life expectancy. 

Vanguard Investment Counseling & Research > 25

Figures 9a and 9b. Degrees of shortfall in cases when spending goals are not met 

Scenario 2: 100% of annuity investment is a 

fixed-payment option 

Scenario 3: Same portfolio as in baseline case; spending goal 

declines each year; a medical shock occurs in the tenth year

No annuity Annuity purchased with tax-deferred assets Annuity purchased with taxable assets

Note: Assumptions are the same as for the benchmark simulation, except as noted. See Appendix B for details of the benchmark simulation 

assumptions.

Source: Vanguard Investment Counseling & Research.

Average shortfall

85 90 95 99

Investor’s age

Estate

85 90 95 99

Investor’s age

–50,000

–40,000

–30,000

–20,000

–10,000

0

–100,000

–80,000

–60,000

–40,000

–20,000

0
Appendix C. Median market returns and inflation rates in the simulations presented

26 > Vanguard Investment Counseling & Research

Summary statistics for asset returns used in simulations

5-year projection 10-year projection 30-year projection

Standard Standard Standard

Return deviation Return deviation Return deviation

Average annual returns and standard deviations (median of simulations)

Cash 3.8% 1.0% 3.8% 1.3% 4.0% 1.8%

Stocks 9.6 16.0 8.9 16.7 9.0 17.1

Bonds 4.7 5.9 4.8 6.4 5.2 6.9

Average yearly inflation rates and standard deviations (median of simulations)

Inflation 2.7% 1.6% 2.7% 1.8% 2.7% 2.2%

Note: Based on simulations generated using the Vanguard Capital Markets ModelTM. The model uses expected asset class returns, volatility, correlations, and economic

and financial market variables to simulate hypothetical investment results through time. The model’s simulations reflect the qualitative professional judgments of the

analytical team in Vanguard’s Investment Counseling & Research group as well as computations based on historical data for these benchmarks: for stocks, the Dow

Jones Wilshire 5000 Index; for bonds, the Lehman Brothers U.S. Aggregate Bond Index; for cash, U.S. Treasury yield data; for inflation, the Consumer Price Index. 

Taxes are not factored into the analysis.

Source: Vanguard Investment Counseling & Research.
Appendix D. Annuity prices used in simulations

Vanguard Investment Counseling & Research > 27

Annuity quotes for a $250,000 purchase on January 2, 2008

Variable annuity with

Date of first Fixed annuity Fixed annuity with 3.5% assumed

Birth date Age payment with flat payment 3% graded increase interest rate (AIR)

1/2/1943 65 1/1/2009 $22,165.80 $16,815.12 $18,299.64 

1/2/1938 70 1/1/2009 24,596.88 19,298.28 21,527.28 

1/2/1933 75 1/1/2009 29,176.80 23,813.88 26,097.36 

Note: These quotes were taken from Vanguard’s website at www.vanguard.com/quote. They were for a single life annuity for a male Pennsylvania resident.

Source: Vanguard Investment Counseling & Research.
Investment products: Not FDIC-insured • No bank guarantee • May lose value

P.O. Box 2600

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Vanguard Investment Counseling & Research

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John Ameriks, Ph.D./Principal

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For more information about Vanguard® funds, 

visit www.vanguard.com, or call 800-662-2739, 

to obtain a prospectus. Investment objectives,

risks, charges, expenses, and other important

information about a fund are contained in the

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before investing.

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ICRUIA 042008
DB-in-DC product, participants will see both their

contract account balance and a guaranteed level

of future income on statements and websites.

These annuity products can describe themselves

as guaranteed because the capital of the issuing

insurer is backing the level of promised income 

at retirement. 

Product offerings 

Several insurers are offering DB-in-DC contracts

under their own brand name or in conjunction

with others. In terms of fixed annuity contracts,

the amount of promised income depends on interest rates and the participant’s age at the time of

investment. Regular contributions into the contract

help mitigate the risk of a one-time annuity

purchase at retirement by allowing participants 

to dollar-cost average into a contract throughout

their accumulation years.

Like traditional balanced or equity options, variable

annuity contracts typically invest a large percentage

of assets in equities, subjecting the participant to

market, manager and similar risks. The guaranteed

income level is based on the market performance

of the contract’s underlying investments. The

promised income is “stepped up” typically on a

participant’s birthday, assuming the underlying

investments have enjoyed a positive return. If 

the portfolio’s value decreases, the guaranteed

amount remains the same. In effect, these 

annuities seek to provide a guaranteed 

income “floor.” 

Research Note

“DB in DC”: Deferred Annuities in Defined Contribution Plans

Authors: William J. Burns, Stephen P. Utkus 

Vanguard Center for Retirement Research May 2008

Conventional deferred annuities are being

repackaged as “DB in DC” investment

options. Various fiduciary and investment

considerations are likely to impede their 

rapid growth. 

A recent development in the retirement 

marketplace is the repackaging of accumulation

(or deferred) annuity contracts as investment

options for defined contribution (DC) plans.

American workers are increasingly receiving

retirement benefits in the form of a DC plan lump

sum, rather than a lifetime annuity from a defined

benefit (DB) plan. Deferred annuities are often

referred to as “DB in DC” products because they

translate the participant’s account balance in the

deferred annuity contract into a DB-like annuity

payout at retirement age. 

Deferred annuity contracts may be offered as

fixed annuities (i.e., offering a stable principal

value and a fixed rate of return) or variable 

annuities (i.e., investing in equities, balanced

funds, life-cycle funds, or similar assets with 

varying risk and return characteristics). Besides

offering exposure to a given asset class, deferred

annuities convert a participant’s current balance

in the contract into an income stream at retirement,

typically at age 65. Participants can also defer

payments until a later age, such as age 70, to

receive a higher monthly income. In the typical

As with any investment, there is risk. Annuity guarantees are based on the claims-paying ability of the underlying insurance companies that issue

the annuity. Variable annuities are long-term vehicles designed for retirement purposes and contain underlying investment portfolios that are subject

to investment risk, including possible loss of principal.
Costs

Like other investment options, annuities incur

costs for recordkeeping and asset management.

In addition, annuity contracts assess an additional

fee (often described as the mortality charge) to

pay for the promised guarantee. The mortality

fees typically cost a minimum of 65 basis points.

These fees vary widely by product and issuer. 

Many investors mistakenly view these mortality

charges as superfluous or hidden investment

charges, but they are not. These expenses

are the cost of the guarantee offered by the

annuity, and so they differ from administrative

and investment costs. 

DB-in-DC annuities may be available at highercost retail or lower-cost institutional levels. They

are typically free of any compensation to a financial advisor or planner—unlike income annuities

that participants might purchase on their own

outside the plan at retirement. 

Valuing the guarantee 

There are several important considerations in

assessing the guarantee offered by a deferred

annuity contract—whether participants will 

actually benefit from it, whether the guarantee 

is fairly priced, and whether the insurer is

adequately capitalized to back the guarantee.

Who benefits from the guarantee? One drawback

with deferred annuities is that many participants

may pay for a guarantee, but never actually benefit from it. For example, young or middle-aged

participants may invest in a deferred annuity, but

then change jobs and move their savings to an

individual retirement account (IRA) or another

employer plan without the annuity option. Older

participants may purchase the annuity, thinking

they may need a guaranteed retirement income

—but then take a lump sum and never annuitize

their balance. In effect, these participants pay the 

cost of a guarantee for years, but never benefit

from it. Deferred annuities can be thought of as

offering participants an option to annuuitize at

retirement—an option that may not be exercised.

Sponsors will be wary of participants who 

misunderstood the costs of the guarantee, and

who may claim that they have been overcharged

for investing in a deferred annuity contract in the

plan. Clear disclosure to participants is critical 

for both fees and the guarantee element. 

The value of the guarantee. With all long-term

insurance promises, it is difficult to assess whether

or not the guarantee is a fair deal. Is the participant

receiving too little future guaranteed income for

their current account balance? Or is the insurer

overpromising guaranteed income for competitive

reasons—and thus will find it more difficult to

keep its promise 10, 20 or 30 years into the

future? It takes a fairly detailed analysis of a

given product to assess its attractiveness. Also:

• The guarantees offered by a contract can change

over time—so guaranteed income from the

dollars participants are contributing today may

be at a higher or lower level than the guaranteed

income from dollars participants are contributing

a decade from today. 

• It can be difficult to compare guaranteed levels

across different products from different companies. For example, guaranteed income levels

will vary based on seemingly subtle variations

in contract features and terms. 

• Some annuities have high retail expense levels,

and others have low institutional expenses,

depending on the size of the assets involved. 

Credit risk of the insurer. A given guarantee is

only as good as the credit quality of the insurer.

Credit quality is typically judged by the insurer’s

claims-paying ability. Moody’s and Standard &

Poor’s claims-paying ratings tend to make finer

distinctions among insurers; A.M. Best ratings

tend to give most insurers high ratings. Claimspaying ratings can change over time. 

2 > “DB in DC”: Deferred Annuities in Defined Contribution Plans
Insurance companies are regulated to protect

against bankruptcy, but the regulatory system is

a patchwork managed by the states. A complete

loss of an annuity contract’s value would be very

unlikely, and regulators would likely organize a

partial or full bailout based on state guarantee

funds. There is no federal guarantee or insurance

program backing annuity contracts. 

Fiduciary duties 

Plan fiduciaries are responsible for the selection

and monitoring of annuity contract providers in

retirement plans. In 2006, the Pension Protection

Act repealed the “safest possible” annuity standard

for DC plans. The Department of Labor (DOL) has

proposed regulations reintroducing a version of

the previous legal standard—what might be

described as the “credit analysis” or “due diligence” standard. As a fiduciary, a sponsor must

undertake a systematic due diligence process to

assess the value of a specific annuity contract. A

sponsor who is unable to make such an assessment is expected to hire an independent expert

to help with the evaluation. 

Other sponsor considerations 

Tax rules. Any annuity contract within a DC plan

must comply with joint and survivor annuity

requirements, as well as rules on reporting

income payouts from the contract. 

Recordkeeping. Many recordkeepers have not 

yet established the administrative infrastructure

to track annuity contracts and report contract

income levels on statements and websites.

Recordkeepers may support one company’s

contracts, but not another’s. This may change

over time if the options become more popular

with sponsors. 

Portability. Given differences in recordkeeping

systems, a sponsor may choose one contract

with a given recordkeeper, only to find that a new

recordkeeper is unable to support it. In addition,

under some contracts, the plan and its participants may face a surrender charge if the plan

decides to switch from one contract to another. 

Rollovers. Portability is also an issue for plan

participants. A participant changing jobs or retiring

will either need to keep contract assets in the plan,

or roll those assets over to the insurer’s equivalent

individual retirement annuity to retain the guaranteed income level. At the time of the rollover, the

participant will likely be transferred into a highercost retail contract. The retail product will require

additional research by the participant in order to

assess whether the product is still suitable relative to its higher fees. 

Advice and education. An increasing number 

of plans are offering online advice or managed

account programs. These programs typically do

not incorporate guaranteed income features into

their planning methodologies. 

Observations 

Several factors appear likely to impede the widespread adoption of “DB in DC” accumulation

annuities. These include such questions as

whether participants will actually exercise a guarantee they have paid for; the difficulty of assessing the fairness of a given guarantee; and the

DOL’s fiduciary standards for annuity providers. 

If DB-in-DC annuities do emerge as a popular plan

option, it will likely be due more to older participants looking to protect themselves against

downside risks as they approach retirement, and

less to young participants seeking to translate

their current balance into an age-65 income

“DB in DC”: Deferred Annuities in Defined Contribution Plans > 3
© 2008 The Vanguard Group, Inc. 

All rights reserved. 

CRRREA 052008

Connect with Vanguard®

www.vanguard.com/retirementresearch > vcrr@vanguard.com

Vanguard, Connect with Vanguard, and the ship logo are trademarks of The Vanguard Group, Inc. 

All other marks are the exclusive property of their respective owners.

Vanguard Institutional 

Investor Group

P.O. Box 2900

Valley Forge, PA 19482-2900

Clear zone: two leading units of space between newsletter content and signature and hedges.

stream. The odds are probably higher that older

participants who choose a deferred annuity will

actually annuitize at retirement and enjoy the

benefit they have paid for. Sponsors who introduce DB-in-DC options will want to ensure that

participants understand the potential benefits,

the higher costs, and the risk that participants

might pay for a benefit they never end up using. 

Finally, the retirement income marketplace is

changing rapidly, with many developments occurring outside the retirement plan system. A new

generation of nonguaranteed payout funds has

been introduced by asset managers. Insurers

have developed new guaranteed products, such

as longevity insurance (which pays an income 

only at a later age, such as 85), and hybrid or

“living benefit” annuities, which provide a guaranteed income and access to assets but with

higher fees. Reverse mortgages of home equity

are an emerging though underdeveloped option. 

Sponsors will want to continue to monitor 

these and other developments in the retirement

income marketplace. Over time, as these strategies

mature, some may become suitable candidates

for inclusion within DC savings plans.

The authors would like to thank John Ameriks,

Ann Combs, Charles Klose, and Frank Nessel for

their comments.
Authors

Gary R. Mottola

Stephen P. Utkus

The authors would like to

thank Michael Schneider,

Wendy Richards, Frederick

Spackman, and Timothy

O’Neill for their assistance 

in obtaining and interpreting

the data used in this research.

Lump Sum or Annuity? An Analysis of 

Choice in DB Pension Payouts 

Vanguard Center for Retirement Research November 2007

Volume 30

Annuitization rates and cash-outs. Twentyseven percent of lump-sum-eligible participants in the traditional plan chose an annuity,

versus 17% in the cash balance plan. These

figures exclude sponsor-initiated cash-outs 

of lump-sum distributions less than $5,000.

Cash-outs represent a large percentage of the

distributions in both plans, and can artificially

inflate overall measures of participant behavior.

Demographics and choice. Older participants

were much more likely to annuitize than their

younger counterparts. Approximately half of

the participants age 70 and older chose an

annuity compared with less than 20% for

participants between ages 55 and 60. In

addition, high-net-worth and male participants

were also less likely to annuitize. 

Actively overcoming defaults. Less than 

one-quarter of married participants in our

study chose an annuity, even though it is the

federally mandated default option for married

couples. Married participants worked actively

to overcome the default annuity option by

submitting a written, notarized waiver. 

Implications. The desire among married participants in their 50s and 60s to “deannuitize” 

a DB plan distribution appears to be quite

strong, and stands in sharp contrast to 

the inertia typically displayed by defined

contribution participants in the accumulation

phase. As a result, plan design and policy

efforts that rely on inertia and default choices

to encourage annuitization within retirement

plans are likely to have only modest effects.

Meanwhile, the fact that annuitization rates

rise with age suggests that the demand for

traditional annuities may arise later in life, at 

an age when many participants have already

retired and left their employers’ retirement

plans. Also, annuity demand may increase in

tandem with the broader trend toward taking

a later retirement. 

Connect with Vanguard® > www.vanguardretirementresearch.com > vcrr@vanguard.com

Executive summary. We assess the lump-sum versus annuity payout choices

made by retirement-age participants in two Fortune 500 defined benefit plans

(one a traditional final-average-pay plan, the other a cash balance plan). Annuitization rates are generally low but rise with age. Also, in contrast to the inertia

that typically characterizes participant behavior in retirement plans, many

married participants work actively to “deannuitize”—to choose a DB lump 

sum over the federally mandated default of a joint-and-survivor annuity. 
Background

Researchers often refer to the “annuity puzzle” when

considering participants who choose a lump sum over

an annuity payout in a defined benefit (DB) or defined

contribution (DC) plan. In theory, many older individuals could benefit from annuity payouts. By pooling

savings during the payout phase, annuitization can

lead to higher retirement incomes and offer protection

against longevity risk, the risk that the individual will

run out of money. Yet when participants are given the

choice, annuity take-up rates tend to be low. 

Changes in the retirement landscape for private-sector

workers have certainly contributed to the trend toward

lump-sum distributions. Nearly half of all private-sector

DB plans now offer a lump-sum option in addition to

standard annuity options. A lump sum is the standard

form of benefit in defined contribution (DC) plans, and

few DC plans offer an annuity payout option.1

Yet when they have the option, why do participants

choose lump sums over annuities in spite of the

theoretical argument for annuitization? There are a

number of plausible explanations for participants’

preferences: 

• Social Security. Participants are entitled to receive

an inflation-indexed government-guaranteed annuity

through Social Security. It may be all of the annuity

income that many participants need or want. 

• Flexibility. Individuals may prefer a pool of assets

for the flexibility it offers in terms of retirement

spending—particularly for large expenditures such

as long-term health care costs. 

• Bequest motives. Participants may want to leave 

a portion of their retirement wealth to heirs 

and charities. 

• Literacy or behavioral constraints. Individuals may

not understand annuities or longevity risk very

well, and may psychologically overvalue large 

lump sums over smaller monthly payouts. 

Other explanations linked to the generally low

demand for annuities include: the problem of adverse

selection, where healthier individuals tend to choose

annuities, thereby making pricing less attractive for

those in poorer health; credit quality concerns (either

the solvency of the DB plan or of a private insurer);

inflation risk associated with fixed-dollar payouts; and

sponsors’ reluctance to offer annuity payouts in DC

plans under current fiduciary rules.2

Our current paper seeks to add to the understanding

of the annuity/lump-sum puzzle by examining distributions from two DB plans, a traditional final-averagepay plan and a cash balance plan. We first present the

annuitization rates for the two plans and analyze the

demographic characteristics related to the annuity/

lump-sum decision. We then examine the impact 

of a federally mandated default, a joint-and-survivor

annuity for married couples, on the decision to

annuitize. We conclude by discussing the

implications of these data. 

2 > Vanguard Center for Retirement Research Volume 30

1 Yaari, 1965; Blotsin, 2003; Poterba, Rauh, Venti, and Wise, 2003; Ameriks, 2004; Dushi and Webb, 2004; U.S. Department of Labor, 2005; and Munnell and 

Perun, 2006.

2 See also Milevsky and Young, 2001; Dushi and Webb, 2004;. Brown, Casey, and Mitchell, 2007; and Ameriks, Caplin, Laurfer, and Van Nieuwerburgh, 2007. 

In terms of fiduciary rules, the Department of Labor’s (DOL) Interpretive Bulletin IB 95-1 required sponsors to select the “safest available annuity,” raising

employer concerns about fiduciary risks. This interpretation was repealed by the Pension Protection Act of 2006, and on September 12, 2007, the DOL issued

proposed fiduciary guidelines. 
Analysis data 

Our data set is drawn from two Fortune 500 DB 

plans for which Vanguard provides DB recordkeeping

services (Figure 1). The first plan is a traditional, finalaverage-pay plan with nearly 39,000 participants as 

of midyear 2007. Between 2000 and 2006, the plan

made more than 7,000 distributions to participants

separating from service. To be eligible for a lump-sum

option, participants had to be age 55 or older with 

at least ten years of service, or 65 or older with no

service requirement. All other participants had to take

an annuity payout (or were cashed out), and so were

excluded from most analyses. 

The second plan is a cash balance plan with nearly

35,000 participants as of midyear 2007. Between

2000 and 2006, the plan made more than 21,000

distributions.3 Nearly all participants were eligible for 

a lump-sum payout; however, for most analyses we

restricted the sample to participants age 55 or older

at termination, because we wanted to improve

comparability with the traditional plan, and because

we wanted to examine the behavior of older

participants near typical retirement ages. 

In both plans, most older participants may choose 

to take a distribution at the time they separate from

service, or defer the distribution until a later date. 

Our analysis, however, focuses on participants at the

time they take the distribution, not when they leave

their employer. Thus, a participant in our data set

taking a distribution at age 70 may be retiring at 70, 

or may have retired many years before and deferred

the distribution decision to age 70. This distinction is

important in interpreting our results, particularly with

respect to age. 

Other institutional features were similar for both

plans. Partial annuitization was not an option: participants in both plans could not split their benefits

between the annuity and lump-sum choices. Participants were notified of their distribution options via 

a fairly complicated letter sent out upon termination

that described the range of distribution options.

Finally, participants were eligible to participate in 

their employer’s 401(k) DC savings plan. 

Volume 30 Vanguard Center for Retirement Research > 3

3 As of December 31, 2005, new hires at this firm were no longer eligible for the cash balance plan and instead received all retirement benefits in an enhanced

401(k) plan.

Figure 1. Overview of Plan Distributions

Traditional Cash balance 

plan plan

Number of participants 38,638 34,855

Number of distributions analyzed 7,131 21,222

Distributions by year

2000 6% 5%

2001 7% 9%

2002 10% 17%

2003 20% 30%

2004 24% 15%

2005 15% 10%

2006 18% 14%

Mean age at distribution 47.7 47.6

Mean household income $78,024 $88,551 

Percent male 74% 66%

Mean service tenure 11.1 13.5

Median 401(k) balance $99,694 $82,538 

Percent affluent* 16% 15%

* Top quintile of nonretirement wealth, based on IXI data.

Source: Vanguard, 2007.
Distribution activity

Under federal law, plan sponsors have the option 

of “cashing out” small retirement plan distributions.

In cash-outs, the sponsor automatically issues a 

check to the participant for the present value of the

participant’s accrued and vested benefit. During 

the 2000–2006 period of our analysis, sponsors 

could initiate cash-outs for present value amounts

less than $5,000.

Both plans in our study utilized automatic cash-outs

and did not retain small balances within their plans. In

both plans, cash-outs represented a large percentage

of the total plan distributions: 51% in the traditional

plan and 27% in the cash balance plan (Figure 2).

4

Because of the high level of cash-outs and lumpsum-eligibility requirements, it is clear that not all

participants had the opportunity to choose between 

a lump sum and an annuity. To examine the decisionmaking behavior of participants who had a choice, 

we excluded cash-outs and lump-sum-ineligible

participants and found that the dominant distribution

was clearly the lump sum. Seventy-three percent of

participants in the traditional plan chose a lump-sum

distribution over an annuity, as did 83% of participants

in the cash balance plan. Annuitization was popular

among a small though meaningful group: 27% of

older participants in the traditional plan and 17% 

in the cash balance plan elected an annuity.

The demographics of choice

Whether in the traditional or cash balance plan,

participants choosing a lump-sum option tended 

to be more affluent, married, and male (Figure 3).

Meanwhile, participants choosing an annuity were

more likely to be less affluent, single, and female. 

In general, lump-sum participants have demographic

characteristics typically associated with higher levels

of financial experience and financial literacy; annuity

participants have characteristics typically associated

with lower levels of financial experience and 

financial literacy. 

Specifically, participants choosing a lump sum had

household incomes that were about 20% higher 

and 401(k) balances that were 30% to 40% higher

(depending on whether they were in the traditional 

or cash balance plan). Lump-sum participants in both

plans were more likely to have high nonretirement

financial wealth. In the traditional plan, 18% of the

lump-sum participants were female, versus 28% 

for annuity participants. 

In the cash balance plan, the gender effect was 

even stronger, with females constituting 24% of 

the participants choosing the lump sum but 46% 

of the participants choosing the annuity. We see a

somewhat smaller effect for the participants’ marital

status: In the traditional plan, lump-sum participants

were more likely to be married, whereas in the cash

balance plan the differences engendered by marital

status were small. 

4 > Vanguard Center for Retirement Research Volume 30

4 Not all cash-outs are necessarily leaving the retirement saving system. Participants may roll over cash-outs to an IRA on their own. Effective in March 2005, 

new rules require that distributions between $1,000 and $5,000 be automatically rolled over into IRAs. 

Figure 2. Distributions by Plan

Traditional Cash balance 

plan plan

All participants

Cash-outs 51% 27%

Lump-sum distributions 22% 63%

Annuity payouts 27% 10%

Excluding cash-outs, 

lump-sum-ineligible participants, 

and participants younger than 55

at termination

Lump-sum distributions 73% 83%

Annuity payouts 27% 17%

Source: Vanguard, 2007.
Another important finding is the strong positive

relationship between age and annuitization (Figure 4).

In the traditional plan, the annuitization rate is 18% 

for participants between ages 55 and 60. The rate

steadily climbs with age and peaks at 46% for

participants 70 and older—a 156% increase in the

annuitization rate. The relationship is even stronger in

the cash balance plan. Again, as noted earlier, the age

we observe is that of the distribution, which may

coincide with, or be later than, the age when the

participant actually separated from service.

Although we see a strong relationship between age

and annuitization, it is possible that other factors are

having an impact. For example, age is correlated with

income and service tenure, so perhaps these factors

(and not age alone) are fully or partially responsible 

for the decision to annuitize. To better understand the

influence of age on the annuity/lump-sum choice, we

used regression analysis to isolate the effect of age

after accounting for a variety of other demographic

variables.5 We conducted a separate analysis for 

each plan. 

Volume 30 Vanguard Center for Retirement Research > 5

Figure 3. Profile of Lump-sum vs. Annuity Distributions

Traditional plan Cash balance plan

Demographic characteristics Lump sum Annuity Lump Sum Annuity

n=1,146 n=422 n=3,328 n=681

Mean age at distribution 60.9 62.7 61.1 66.0

Mean household income $99,227 $84,000 $87,250 $72,648 

Percent male 82% 72% 76% 54%

Mean service tenure 25.6 24.2 23.6 24.0

Percent married 79% 71% 76% 72%

Mean 401(k) balance $241,689 $168,299 $166,177 $127,297 

Percent affluent* 36% 24% 25% 16%

* Top quintile of nonretirement wealth, based on IXI data, in which data from the IXI company were used to inpute nonretirement plan household financial

wealth at the standard United States Postal Service delivery address designation ZIP+4 level.

Note: Excludes cash-outs, lump-sum-ineligible participants, and participants younger than 55 at termination.

Source: Vanguard, 2007.

18%

Figure 4. Annuitization Rate by Age

0

70%

Annuitization rate

55 to 60

7%

28%

16%

40%

28%

46%

62%

60 to 65 65 to 70 70 +

% of Participants 50 to 60 60 to 65 65 to 70 70 +

Traditional Plan 38% 43% 16% 3%

Cash Balance Plan 37% 41% 16% 6%

Note: Excludes cash-outs, lump-sum-ineligible participants, and 

participants younger than 55 at termination.

Source: Vanguard, 2007.

Traditional Cash balance

Age

5 Detailed results from our logit models, including coefficients and marginal effects, are available from the authors upon request.
Our regression results indicate that

even after adjusting for a host of

demographic factors, age plays a

very prominent role in the annuitization decision. In the traditional 

plan (Figure 5), a five-year increase

in age is associated with an eight

percentage point increase in the

likelihood to annuitize. Consistent

with our earlier findings, other

demographic variables influence the

annuitization decision in this plan.

For example, married, male, and

high-balance participants are less

likely to annuitize. 

Another way to gauge the impact 

of age is to compare the effect with

the overall annuitization rate in the

traditional plan. While the approach

only provides us with an approximation, it suggests that for every

five-year increase in age the likelihood that a participant will choose

an annuity rises from 27% to about

35%. If we increase the participant’s

age by ten years, the likelihood of

choosing an annuity increases 

to 43%.

In the cash balance plan (Figure 6),

age is also the dominant factor

driving the annuitization decision.

Similar to the data for the traditional

plan, a five-year increase in age

shows a seven percentage point

increase in the likelihood to annuitize.

Since the overall annuitization rate 

in the cash balance plan is lower

than the traditional plan, age

represents an even stronger effect.

For example, if we raise the age of

the average participant by five years,

the likelihood to annuitize increases

from 17% to about 24%—a 41%

increase. 

6 > Vanguard Center for Retirement Research Volume 30

Figure 5. Factors Related to Annuitization in the Traditional Plan

Change in probability of choosing an annuity % change in probability of choosing an annuity

Age (5)**

** Indicates variable significant at the .05 level.

* Indicates variable significant at the .10 level. 

Note: Excludes cash-outs, lump-sum-ineligible participants, and participants younger than 

55 at termination.

Source: Vanguard, 2007.

High

balance**

Male** High

wealth**

Married* Low

income

Service 

tenure (5)

High

income

Low

balance

–10

–8

–4

0

4

8

10%

2

6

–2

–6

Figure 6. Factors Related to Annuitization in the Cash Balance Plan

Change in probability of choosing an annuity % change in probability of choosing an annuity

Age (5)**

** Indicates variable significant at the .05 level.

* Indicates variable significant at the .10 level. 

Note: Excludes cash-outs, lump-sum-ineligible participants, and participants younger than 

55 at termination.

Source: Vanguard, 2007.

High

balance**

Male** Low

income*

Service

tenure (5)

Low

balance

Married High

wealth

High

income

–10

–8

–4

0

4

8

10%

2

6

–2

–6
Our two regression models underscore the importance of age in influencing the choice between 

lump-sum and annuity payouts. However, to varying

degrees, wealth, gender, and marital status also play

a role in the decision to annuitize.

Default impact 

Under federal law, a joint-and-survivor annuity is the

mandated default option for married participants. To

receive a lump sum, married participants must have

their spouses waive their right to a joint-and-survivor

annuity in writing. The document must be notarized,

which requires the payment of a small fee, and both

spouses must be physically present in front of the

notary to sign the waiver. If inertia was a dominant

decision heuristic among participants making this

distribution choice—as it is among DC participants

during the accumulation phase of retirement

savings—we would expect a much higher rate 

of annuitization among married participants. 

Yet the actual annuitization rate by marital status 

is exactly the opposite of what we would expect

(Figure 7). In the traditional plan, married participants

are much less likely to annuitize than single participants, while in the cash balance plan, marital status

produces no material differences. Furthermore, the

overall level of annuitization for married couples is

quite low—25% in the traditional plan and 16% in 

the cash balance plan. 

From a behavioral perspective, these findings are

striking. It appears that when it comes to accessing

their money at retirement, married participants are

actively engaged decision-makers. This is in sharp

contrast to the inertia that characterizes 401(k)

enrollment, trading, and rebalancing behavior. 

Married participants work actively to “deannuitize”—

to overcome the federally mandated default of a jointand-survivor annuity and choose a lump sum instead. 

The fact that deannuitizing requires the physical

presence of both spouses in a specific location in

front of the notary, and the payment of a small fee, 

is even more compelling evidence of the absence 

of inertia.

Our findings underscore a powerful drive to

deannuitize and a willingness to make active choices

at retirement. Perhaps this heightened engagement

arises because distribution decisions at retirement

have a large and immediate impact on a participant’s

financial situation, whereas 401(k) enrollment and

investment decisions have a more subtle and distant

impact. In any event, as suggested by the evidence

from our two plans, it would appear that the payout

phase is qualitatively different than the enrollment and

savings phase of the retirement life-cycle, and, as

such, it may require different approaches to optimize

behavior and enhance retirement security.

Volume 30 Vanguard Center for Retirement Research > 7

Figure 7. Annuitization Rates by Marital Status Annuitization rate

Traditional

Note: Excludes cash-outs, lump-sum-ineligible participants, and 

participants younger than 55 at termination.

Source: Vanguard, 2007.

0

40%

Married Single

25%

36%

16%

18%

Cash balance
Conclusions and implications

The debate over lump-sum versus annuity payouts 

is likely to continue as the availability and use of

annuities within private-sector retirement plans

declines. Our research sheds light on this debate 

by confirming that in the context of the lumpsum/annuity payout decision in two large DB plans,

annuitization rates are low, although not as low as

commonly cited.6 We also find evidence of rising

annuity demand among participants taking distributions from their retirement plans at older ages. Finally,

it seems clear that there is a strong desire for married

couples to “deannuitize,” with many actively working

to overcome the federally mandated default of a jointand-survivor annuity. 

These findings offer several implications for plan

sponsors, financial services firms, and policymakers.

First, particularly in the early stages of retirement,

there is strong demand among participants for lumpsum distributions. Some will argue that this decision

represents a misjudgment in terms of financial literacy.

But there are equally valid arguments that it is a

rational decision, given the annuity payouts from Social

Security and retiree concerns about flexible spending.

If participants are to benefit from pooling of longevity

risks, a new generation of financial products—those

permitting flexible access to savings and longevity

guarantees—may be a possible way forward.

Second, there still is some latent demand for

traditional annuitization, particularly among older

participants. In our two plans, a significant minority 

of participants chose the annuity option at younger

ages, but this rate rose to about half among older

participants taking a distribution. This result suggests

that annuity demand may occur at older ages, and

that the prevalence of lump-sum distributions is the

result of many individuals exiting their employers in

their 50s and early 60s. Furthermore, since retirement

age seems likely to increase in the coming years for a

number of reasons—including the increase in Social

Security’s normal retirement age and rising health

care costs—annuities may become a more

compelling option for an aging workforce. 

For some sponsors and policymakers, these

developments may argue for offering or encouraging

annuity payouts in DC retirement plans. Yet at the

same time, there is a strong desire to “deannuitize,”

and many sponsors are concerned with the fiduciary

liability of offering an annuity plan option within a DC

plan. An alternative strategy might be to promote

education addressing the annuity versus lump-sum

payout decision, and to accommodate annuity options

“beyond the plan,” particularly at older ages. 

Third, the most striking behavioral result from 

our research is the absence of inertia in the lumpsum/annuity decision, as evidenced by the fact that

married couples actively work to avoid the federally

mandated default option. At retirement, participants

8 > Vanguard Center for Retirement Research Volume 30

6 We believe that in some cases the very low annuitization rates cited reflect annuitization rates for defined contribution plans. For example, Milevsky and Young,

2001, using HRS data report that 8% of respondents with a defined contribution plan chose an annuity payout. 
are more likely to exert themselves to make active

choices, and the model of decision-making that

applies during their accumulation years (the model 

of the disengaged participant) seems no longer valid.

This suggests that education and communication

programs can have a stronger impact on participants

at the critical juncture when they are about to leave

their employers and embark on their retirement.

Fourth, neither plan in our study allowed a participant

to split their distribution between an annuity and 

a lump-sum payout. However, this might be an

appealing option for participants seeking to balance

control over their assets with a desire for some

longevity protection. It is true that allowing split

distributions would add administrative costs to the

plan and complicate the annuity/lump-sum decision

for participants. Yet forcing an “all or nothing” decision

may be counterproductive. It remains to be seen

whether such split distributions would actually alter

the annuity versus lump-sum balance, whether it is

offered as a voluntary option or as a default. 

Finally, several caveats are in order. Given that our

sample consists of only two plans, it is impossible 

to determine whether our results are due to the plan

design (traditional versus cash balance) or whether

they are related to other unique factors associated

with the two firms or workforces. Therefore, we

cannot conclude that the cash balance plan leads to

lower annuitization rates because of its hybrid design,

but our findings suggest that this is a possibility

worthy of future research. 

Similarly, the level of interest rates over time 

affects the value of a lump-sum payment relative 

to an annuity. Both the generally low interest rate

environment of the last several years, along with the

uniquely low yields of 30-year Treasury bonds, may

have increased the percentage of participants opting

for a lump sum. While our regression models take

time effects into consideration, we could not adequately

examine the relationship between interest rates and

the annuity/lump-sum payout decision because of

data limitations. Future research with a larger sample

of plans and more time-series data will be needed to

examine these issues. 

Volume 30 Vanguard Center for Retirement Research > 9
References

Ameriks, John, 2004. “How Do Retirees Go From

Stock to Flow?” Pension Design and Structure: New

Lessons From Behavioral Finance, Olivia S. Mitchell

and Stephen P. Utkus, eds., Oxford University Press.

Ameriks, John, Andrew Caplin, Steven Laufer, and

Stijn Van Nieuwerburgh, 2007. The Joy of Giving or

Assisted Living? Using Strategic Surveys to Separate

Bequest and Precautionary Motives. NBER Working

Paper 13105.

Blotsin, Allan P., 2003. Distribution of Retirement

Income Benefits. Monthly Labor Review.

Brown, Jeffrey R. and Mark Warshawsky, 2001. 

“The Costs of Annuitizing Retirement Payouts from

Individual Accounts.” In The Role of Annuity Markets

in Financing Retirement. Jeffrey R. Brown, Olivia S.

Mitchell, James M. Poterba, and Mark J. Warshawky,

eds. Cambridge, Massachusetts: The MIT Press.

Brown, Jeffrey R., Marcus Casey, and Olivia Mitchell,

2007. “Who Values the Annuity From Social Security?

New Evidence from the Health and Retirement

Study.” Paper presented at the 2007 Pension

Research Conference.

Dushi, Irena and Anthony Webb, 2004. “Household

Annuitization Decisions: Simulations, and Empirical

Analyses.” Center for Retirement Research at Boston

College Working Paper 2004–04.

Milevsky, M.A. and V.R. Young, 2001. “The Real 

Option to Delay Annuitization: It’s Not Now-or-Never.”

York-Schulich-Finance Working Paper No. MM11-1.

Milevsky, M.A. and V. R. Young, 2002. “Optimal Asset

Allocation and the Real Option to Delay Annuitization:

It’s Not Now-or-Never.” Working Paper, The Schulich

School of Business, York University, Canada.

Munnell, Alicia H. and Pamela Perun, 2006. “An

Update on Private Pensions.” Center for Retirement

Research at Boston College, Number 50.

Poterba, James, Joshua Rauh, Steven Venti, and

David Wise, 2003. “Utility Evaluation of Risk in

Retirement Savings Accounts,” NBER Working 

Paper 9892.

U.S. Department of Labor, 2005. “National

Compensation Survey: Employee Benefits in Private

Industry in the United States,” 2003. Bulletin 2577.

Yaari, Menahem E., 1965. “Uncertain Lifetime, Life

Insurance, and the Theory of the Consumer,” Review

of Economic Studies, 32: 137–150. 

10 > Vanguard Center for Retirement Research Volume 30

Vanguard Institutional 

Investor Group

P.O. Box 2900

Valley Forge, PA 19482-2900

Connect with Vanguard® > www.vanguardretirementresearch.com > vcrr@vanguard.com

Vanguard, Connect with Vanguard, and the ship logo are

trademarks of The Vanguard Group, Inc. 

© 2007 The Vanguard Group, Inc.

All rights reserved. 

CRRLSA 112007

Contributors

Samuel Atlee 

Rebecca Freedman

John Friel

Susan Fuhs

Amy Hoffman
Authors

Gary R. Mottola

Stephen P. Utkus

The authors would like 

to thank John Ameriks,

William Burns, and 

Ann Combs for their 

helpful comments.

The Retirement Income Landscape

Vanguard Center for Retirement Research December 2008

Volume 34

Executive summary. A new generation of retirement income products 

has emerged in the marketplace. Payout funds simplify the process of

establishing a withdrawal program from a portfolio. Living benefit annuities

offer guaranteed income and access to underlying assets. Investors and

advisors face the challenge of crafting retirement income plans that integrate

traditional income-generating strategies with these newer offerings. 

Retirement income framework. As in their

accumulation years, investors in the spenddown phase must strike a balance among 

risk, return, and cost. They need to weigh

competing objectives for their assets (regular

income, spending flexibility, survivor needs,

and bequests), while considering a range 

of risks, including the unique risk of the

deaccumulation phase—longevity risk.

Meanwhile, they must seek to minimize

investment costs, the costs of guarantees,

and the impact of taxes. 

Nonguaranteed options. The conventional

strategy for generating income from a

portfolio is a systematic withdrawal plan

(SWP). In an SWP, portfolio withdrawals are

based on some spending rule, applied to the

value of the portfolio over time. The main risk

of an SWP is longevity risk—either spending

too quickly and depleting savings, or spending

too meagerly and leaving too much to one’s

heirs. Payout funds, which integrate an SWP

within a mutual fund, simplify the process of

establishing such plans.

Guaranteed options. Immediate income

annuities eliminate market and longevity risks

in retirement. Yet they remain unpopular with

investors for several reasons, not least of

which is that the contracts are illiquid and

irreversible. A new generation of living benefit

annuities offers a guaranteed income, the

potential for future growth, and access to

underlying capital at fair market value.

However, costs can be high, and the

guaranteed element depends critically on 

the insurer’s skill at hedging capital markets

risk. Meanwhile, other guaranteed strategies,

such as longevity insurance and reverse

mortgages, remain underdeveloped.

Connect with Vanguard® > www.vanguard.com/retirementresearch > vcrr@vanguard.com
Introduction 

The question of how to generate a sustainable

income stream from a pool of retirement savings 

is emerging as a critical issue in the United States.

Increasingly, American workers in the private sector,

whether in defined contribution (DC) plans or defined

benefit (DB) plans, are taking their plan benefits as 

a lump sum rather than a lifetime annuity. They face

the challenge of translating their lump-sum savings

into a regular stream of payments in retirement. 

Today, nearly two-thirds of American households in

their mid-career own some type of tax-advantaged

retirement savings account, through a 401(k) or 

similar savings plan, an IRA, or other tax-deferred

account (Figure 1). By comparison, only about one 

in three Americans age 75 and older owns a

retirement account. 

Meanwhile, life expectancies are rising and 

retirement health care costs are growing. Future

retirees must ensure that their savings last longer 

and keep pace with inflation. They will need regular

income from their savings, as well as the flexibility 

to tap their assets for unpredictable expenses, such

as out-of-pocket health care costs and long-term 

care expenses. 

In this report, we describe the current state of the

retirement income landscape. The marketplace is in 

a period of rapid innovation, as new strategies are

devised by asset managers, insurers, and banks to

meet the retirement income needs of the baby boom

generation. We begin with an overview of the issue

using a risk, return, and cost framework. We then

consider traditional strategies for generating income

as well as new approaches. We conclude with

recommendations for individuals, advisors, plan

sponsors, and policymakers. 

This report can be read in conjunction with other

Vanguard retirement income research, including

papers on annuities generally, the role of annuities

in DC plans, and the retirement income behavior 

of older American households.1

Implications. As the baby boomers retire and more

Americans receive savings in the form of a lump sum,

the challenge they face is not a lack of retirement

income products and strategies. Rather, for both

individual investors and advisors, the main challenge

appears to be how to create a personalized retirement

income plan from both traditional and newer income

options. Such a plan would integrate nonguaranteed

and guaranteed elements and be tailored to an

individual’s preferences for return, risk, and cost. 

For plan sponsors and policymakers, it remains to 

be seen which of the newer strategies will emerge 

as payout mechanisms within defined contribution

(DC) plans. For the time being, most of the

innovations are likely to be adopted “beyond the 

plan” for use within IRAs. 

1 See Vanguard 2008a, 2008b, 2008c, and 2008d.

58%

63%

43%

29%

0

20

40

60

80%

45–54 55–64 65–74 75+

Source: Federal Reserve Board, Survey of Consumer Finances (2004).

Figure 1. Incidence of retirement accounts

Percentage of households with a tax-advantaged 

retirement account

Age

2 > Vanguard Center for Retirement Research Volume 34
Volume 34 Vanguard Center for Retirement Research > 3

I. Retirement income framework

Generating an income stream for routine living

expenses using assets held in a long-term retirement

account has often been described as creating a

“paycheck for life.” However, although generating

regular income is a top priority, it is only one element

in a complex set of trade-offs that investors must

navigate among risk, return, and cost. 

In retirement, most individuals have three broad

return objectives (Figure 2): 

• Generating a regular income stream for predictable

or regular living expenses.

• Meeting discretionary or unpredictable spending

needs, such as out-of-pocket health care costs or

long-term care costs, or even unexpected housing

or transportation expenses.

• Providing bequests to survivors, heirs, or charities. 

The emphasis on each objective will vary from

individual to individual, and over time in retirement.

But all three typically play some role in an individual’s

decision-making. 

Another important element of a retirement income

strategy is the desire to mitigate financial risks. As in

their accumulation years, individuals face the usual

investment risks of markets, managers, and inflation.

But unique to the drawdown phase is longevity risk:

the risk of spending down savings too quickly and

thereby depleting assets prematurely. 

Longevity risk, however, is not solely the risk of

overspending. It is also the risk of underconsumption

or underspending. In other words, longevity risk can

also mean spending too little in retirement, out of fear

of depleting savings, and leaving too much in the form

of residual bequests. In the end, the challenge in

managing longevity risk is to balance the risk of being

a spendthrift against the risk of excessive frugality. 

Retired individuals must also consider three types of

costs: investment costs, guarantee costs (the cost of

providing protection against market, longevity, or other

risk), and taxes. All things being equal, higher costs 

will reduce an individual’s ability to achieve a given

goal for a given level of risk. Lower costs will enhance

an individual’s ability to achieve a given goal. 

Decisions about how to spend money from a longterm retirement account take place in the broader

context of other income-related decisions, including: 

• Timing of retirement. One of the most significant

errors individuals can make is retiring too early 

and having inadequate resources. Postponing

retirement can improve retirement income levels.

Some individuals retire gradually using a phased

approach, while others stop work entirely. In some

ways, the choices of a retirement age and an

approach to retirement may be the most critical

retirement income decisions preretirees make. 

• Social Security and DB plans. Social Security

benefits are more generous the longer an

individual waits to enroll. For participants with DB

plans, the choice between an annuity or lump sum

(if offered) has a major effect on the timing of

income needs.2

• The house. Most older Americans own their home,

raising the issue of how home equity might be

used to generate retirement income. Although

home equity levels have fallen recently because of

declining house prices and rising debt levels, home

equity is likely to remain an important retirement

resource beyond the current credit cycle.

Cost

Risk Return

 Return

• Regular income stream

• Flexible spending needs

• Survivors and bequests

 Risk

• Investment risks 

 (market, manager, credit)

• Inflation risk

• Longevity risk

 Cost

• Investment costs

• Guarantee/insurance costs

• Taxes

Figure 2. Retirement income framework

Source: Vanguard, 2008.

2 While DB plans are in general decline among private sector workers, there are still millions of households with private- or public-sector DB pensions.
4 > Vanguard Center for Retirement Research Volume 34

• Debt management. As they approach retirement,

older households need to consider how to manage

outstanding mortgage, installment, and credit 

card debt. 

• Health insurance. Health insurance is an important

element in determining income needs. Before age

65, individuals not covered by employer plans need

to purchase coverage, if it is available. After they

are eligible for Medicare at age 65, they face

expenses for supplemental insurance and other

out-of-pocket costs, as well as the potential

expense of long-term care.

• Household focus. Decisions about retirement

income are often household decisions—for

example, the decision of one’s spouse or partner 

to elect a DB plan annuity or take a lump sum may

alter one’s own retirement income preferences. 

It is within the context of these choices that

individuals must decide upon the orderly and 

tax-efficient liquidation of their savings over time. 

To address investors’ retirement income needs, an

array of investment, insurance, and banking products

has emerged in the marketplace (Figure 3). One set

of strategies is portfolio-based. These strategies do

not provide guaranteed income streams, but use

portfolio diversification and spending policies to

manage certain elements of risk. 

A second set of strategies is based on annuity-type

products and offers a guarantee. In exchange for

some explicit or implicit cost, these strategies

typically provide a guaranteed level of income, an

income guaranteed for life, or both. 

The remainder of this report assesses these two

types of strategies in detail. We also consider other

less developed approaches, such as longevity

insurance, reverse mortgages, and “DB in DC”

accumulation annuities.

II. Nonguaranteed options

Two common strategies for generating income in

retirement from a portfolio—on a nonguaranteed

basis—are income investing and SWPs. Meanwhile 

a third option, the payout fund, has emerged as 

a way to simplify the creation of an SWP. 

Income investing

Perhaps the simplest strategy for generating income

from savings is income investing—spending only

interest, dividends, or other investment income from

a portfolio. The portfolio can be invested in bank

deposits, mutual funds, stocks, bonds, or other

instruments. By “never touching principal” and

consuming only investment income, investors are 

in some sense able to self-insure against the risk 

of depleting savings. 

Figure 3. Retirement income landscape

Other retirement income solutions include: “DB in DC” deferred annuities, longevity insurance, and reverse mortgages.

*Such as a guaranteed minimum withdrawal benefit (GMWB) annuity.

Source: Vanguard, 2008.

First generation

Second generation

Portfolio-based strategies

Income investing

Systematic withdrawal plan (SWP)

Payout funds

Annuity or other 

guaranteed strategies

Immediate income annuity

“Living benefit” annuity*
Volume 34 Vanguard Center for Retirement Research > 5

With income investing, investors are exposed to the

conventional risks associated with any portfolio-based

strategy, such as market risk, manager risk, and

inflation risk. Income investors also face income

volatility risk—the risk that income levels may rise and

fall with market yields. At the same time, an income

investor’s assets are liquid and portable and can be

accessed flexibly as needed. 

In structuring a portfolio to generate income, investors

must make trade-offs among the current level of

income offered, the stability of income over time,

along with the potential for future income growth. 

For example, stock dividends offer low yields but the

potential for higher future income growth; bond yields

are typically much higher, but with negligible growth. 

Inevitably, if income investors seek to maximize

current income only, their portfolios will suffer,

becoming poorly diversified. They will be concentrated

in asset classes with high current yields, such as

value stocks, real estate investment trusts, and 

long-duration corporate bonds; and underweighted 

in asset classes where return comes mainly from

capital gains, which would include stocks in general 

or small-capitalization and emerging markets equities

in particular. 

This underscores an important drawback of income

investing. Equity and fixed income yields have fallen

in recent decades (Figure 4).3 Meanwhile, the portion

of future equity returns expected from capital gains

has risen. When they adopt an income investing

strategy, investors choose to live off modest income

yields—while leaving their initial capital, plus all future

capital gains in retirement, to their beneficiaries. In

effect, income investors are underutilizing their savings

in financing their own retirement in favor of the needs

of their survivors, heirs, and charitable bequests. 

As a result, income investing is likely to be appealing

in a few specific situations. It’s useful for investors

who want a simple strategy to generate some

income from their savings. It’s also suitable for

affluent investors who are satisfied with lower yields

from their savings and plan to leave much of their

capital to others. 

4.7%

3.1%

4.1% 4.1%

2.3%

1.6%

3.1%

4.9%

7.5%

10.2%

6.4%

4.5%

0

2

4

6

8

10

12%

Figure 4. Asset class yields, 1950–2007

* 2000–2007.

Source: Vanguard, 2008.

1950s 1960s 1970s 1980s 1990s 2000s*

S&P 500 yield 10-year Treasury note yield

3 A major portion of the decline in fixed income yields since the 1970s has been, of course, the decline in inflation, not in real yields.
6 > Vanguard Center for Retirement Research Volume 34

Systematic withdrawal plans 

An alternative to income investing is the adoption 

of some form of installment or SWP from a portfolio.

With an SWP, an investor manages assets on a

diversified total return basis and adopts a rule for

gradually spending down the portfolio. The amount

withdrawn can include investment income, capital

gains, or initial principal. In this way, the investor’s

spendable income is not limited to portfolio yield 

but can be based on initial capital and the portfolio’s

total return. 

SWP strategies can be simple—for example, a plan 

to withdraw a fixed percentage or dollar amount per

year (Figure 5). They can also be more elaborate. 

For example, using a strategy like that of some

endowments, an investor might apply a rollingaverage spending rule, such as spending 5% of the

average value of his account over the prior three 

or five years. 

Another SWP strategy popular with some financial

planners is the so-called “4% rule.” In the first year 

of retirement, an individual spends 4% of his entire

retirement savings. In each subsequent year, the

dollar value of the withdrawal is increased by 

the rate of inflation. For example, a retiree with

$100,000 would spend $4,000 in the first year 

of retirement. If inflation were 2% during the 

year, his withdrawal for the subsequent year 

would increase to $4,080—2% more than the

previous year. In effect, the retiree pays himself 

an annual cost-of-living increase on the amount

withdrawn from his portfolio. 

Other SWP strategies include the modeling of

withdrawals using sophisticated simulation

techniques, and ensuring that withdrawals are

structured to minimize taxes.

The goal of any SWP strategy is to provide some

reasonable level of income over time, and ideally 

to have that income grow with inflation. The main

obstacle is longevity risk: setting a withdrawal 

amount too high and depleting assets prematurely

during retirement. The greatest risk of asset depletion

occurs when an investor takes large withdrawals at 

a time of poor market returns. This is particularly true

in the early years of retirement, when, in an example

of “reverse compounding,” high withdrawals and 

poor returns can combine over time to exhaust 

capital in the later years of retirement.

Figure 5. Types of systematic withdrawal strategies

Spending rule Example

Simple % or $ spending rule Withdraw 3% of assets per year. 

Withdraw $500 per month.

Endowment-like rule Withdraw 5% of average of three prior years’ asset value.

4% or 41

⁄2% rule Spend 4% or 41⁄2% of total retirement savings in first year of retirement. 

Increase dollar amount by inflation rate each year thereafter.

Monte Carlo or other simulations Model withdrawal rates simulating effects of changing investment returns; 

adjust spending accordingly.

Tax-sensitive withdrawals First withdraw assets from Roth savings or taxable assets subject to preferential 

capital gain tax rates. Postpone taxable pre-tax withdrawals.

RMD withdrawals Spend only required minimum withdrawals from IRAs and other retirement plans 

once age 701⁄2 and older (see page 7).

Source: Vanguard, 2008.
Volume 34 Vanguard Center for Retirement Research > 7

0

1,000

2,000

3,000

4,000

5,000

$6,000

Age

Note: Assumes $100,000 initial investment and a 3% real return. See text. 

Source: Vanguard, 2008.

70 75 80 85 90 95 100

Figure 6. RMD withdrawals

Required minimum distributions (RMDs) from a $100,000 portfolio

RMDs as an income strategy?

One possible strategy for an SWP is to base withdrawals

on the tax rules for required minimum distributions

(RMDs). Federal tax law requires investors in IRAs and 

DC plans to begin taking RMDs from their accounts once

they reach age 701

⁄2. Because of this provision, some DC

plans actually include life-expectancy-based withdrawals

as a plan distribution option for retirees. 

Are RMDs a suitable approach to generating a long-term

retirement income? The short answer is, sometimes

yes—and sometimes no. 

Consider an investor at age 701

⁄2 with $100,000 in his IRA

as of the prior year. His first-year RMD is approximately

$3,800 (Figure 6). Assume that the investor decides to

spend all of his RMD each year. Also assume his account

grows at a 3% real rate of return, which permits us to

compare his real purchasing power over time and ignore

the volatility of investment returns. 

Under the RMD rules, the investor’s real purchasing

power grows over time, reaching a peak of nearly $5,300

in current dollars by age 89. But then, if the investor lives

to age 90 or beyond, his RMD amount falls in real terms.

There is a sharp drop in his standard of living for 

every year he lives beyond 90. In effect, an investor 

who is fortunate enough to live a long life is penalized 

by a significant decline in the real value of his 

retirement spending. 

Besides this risk, RMDs have risks similar to other simple

SWPs. By using a percentage of an account balance once

a year, the investor can experience significant increases or

decreases in the amount withdrawn, depending on how

volatile the underlying portfolio is.

For these reasons, RMD withdrawals from IRAs or DC

plans, while essential to comply with tax laws, may not

be a sustainable strategy for generating a predictable

retirement income. At the margin, they can be a simple

way to generate some income. But for those who live a

long life, there is the risk that the RMD income level falls

sharply in one’s 90s. And portfolio income can be volatile

depending on how the underlying assets are invested. 
8 > Vanguard Center for Retirement Research Volume 34

As an illustration, consider applying the 4% rule 

to a $100,000 portfolio over a 30-year period in

retirement (Figure 7). If the initial withdrawal rate 

in the first year of retirement is $4,000 (4%) or less,

with inflation adjustments in future years, there have

been no historic periods in which an investor would

have depleted capital in 30 years. But if the investor

started with a $5,000 withdrawal in the first year,

again with subsequent inflation adjustments, there 

is a 13% historical chance of running out of money. 

At higher starting levels—for example, a $7,000

withdrawal in the first year with subsequent inflation

adjustments—there is nearly a 50-50 chance of

depleting capital. This risk arises, of course, not 

simply because the investor has made the initial 

7% withdrawal, but that the withdrawal amount

increases each year by the cost of living. 

These simulations raise several broader issues: 

• The typical investor or advisor is unlikely to 

follow a given spending strategy naively until 

one day the portfolio runs out of money. In the

event of poor market returns, for example, an

investor can reduce spending from the portfolio, 

or at least stop increasing the amount spent. This

is just longevity risk in another form—not the risk

of running out of money per se, but the risk of

having to reduce spending to ensure that one’s

savings last. 

• These figures show the risks of completely

depleting one’s retirement savings. But even 

in some of the “successful” outcomes, 

an investor’s retirement savings might fall

dramatically in value. So, while the investor’s

account balance might still be positive, he 

could perceive his assets as having been

substantially exhausted.

• These simulations are based on a balanced

portfolio of 60% U.S. stocks and 40% U.S. 

bonds. An even more diversified portfolio, 

such as one holding international stocks 

or other noncorrelated investments, might 

lead to a higher probability of success with 

this SWP strategy or any other. However, 

historical simulations have their limitations. 

Future returns could always be lower, in 

which case the probability of loss could be 

higher than expected. 

Payout funds

Investors seeking to establish an SWP from their

portfolio face a number of important decisions. 

At what rate should money be withdrawn? How

should the portfolio be invested if it is being used 

to generate a regular stream of withdrawals? What

approaches can be used, both in terms of investment

strategy and spending rate, to manage the risks of

running out of money? For many investors, answering

these questions can be daunting. In spending down

their assets today, most individuals appear to rely on

relatively unstructured approaches.4

Note: Assumes a 60/40 stock and bond portfolio from 1926–2007.

Important: The projections or other information generated by this 

analysis regarding the likelihood of various investment outcomes 

are hypothetical in nature, do not reflect actual investment results, 

and are not guarantees of future results. 

Note: This analysis does not consider taxes. Annual returns and inflation for 

a given asset allocation are based on historical data from 1926 through 2007. 

Past performance is not a guarantee or a prediction of future results. Stock 

market returns are for Standard & Poor’s 500 Index from 1926 to 1970, the 

Dow Jones Wilshire 5000 Index from 1971 through April 22, 2005, and the 

MSCI U.S. Broad Market Index thereafter; bond market returns are based 

on the Standard & Poor’s High Grade Corporate Index from 1926 to 1968, 

the Citigroup High Grade Index from 1969 to 1972, the Lehman Long-Term 

AA Corporate Index from 1973 to 1975, and the Lehman Aggregrate Bond

Index thereafter. Results may vary with each use and over time. 

Source: Vanguard, 2008.

0% 0%

13%

29%

44%

$3,000 $4,000 $5,000 $6,000 $7,000

Figure 7. The risk of inflation-adjusted 

systematic withdrawals

Historical chance of depleting savings over a 30-year period

0 

10 

20 

30 

40 

50%

Initial withdrawal in year one (with inflation adjustments thereafter).

4 See Vanguard, 2008d, for details.
Volume 34 Vanguard Center for Retirement Research > 9

Payout funds have been created by asset managers

to simplify such decisions. The aim is to streamline

the process of establishing an SWP—in essence, to

delegate the complex decisions about withdrawal

rates and portfolio strategy to the fund manager.

Payout funds combine a standardized or algorithmic

spending rule along with a customized investment

strategy, while using the mechanics of mutual fund

distributions to make actual payouts to investors. 

Payout funds come in two types: 

• Endowment-like funds. Endowment-like payout

funds mimic the characteristics of a university or

other charitable endowment. They are designed to

generate regular payouts and preserve capital over

the long term. A simple approach might be to

distribute a portion of a fund’s assets each year.

Another might be to use a more complex spending

rule—such as 5% of the rolling three-year average

net assets of the fund. 

• Time horizon funds. Time horizon payout funds 

are intentionally self-liquidating over a specific

horizon, such as 10, 20, or 30 years. Their aim is to

provide regular payouts from earnings and capital

consistently over a given time period. Ideally, at 

the fund’s termination date, the account is

generally exhausted with the final payout.

Conceptually, both types of funds make critical tradeoffs between the initial level of the payout, growth of

the payout and capital, and time. As an example,

endowment-like funds may offer a choice between 

a low initial payout with high future growth potential

and a high initial payout with little growth potential. 

The two types of payout funds have varying uses.

Endowment-like funds by their design are intended 

to produce regular payouts in perpetuity. The payouts

can be used for living expenses with the residual

value available for bequests. Time horizon funds can

be used to provide additional spendable income over

a specified period—including payments for a specific

debt obligation, such as a mortgage, or for higher

discretionary spending during the early active years 

of retirement. 

Payout funds are investment, not insurance, vehicles,

and thus the payout amount and any expected future

growth of capital are not guaranteed. They are not

guaranteed income solutions. Payout amounts and

account balances will fluctuate and can decline. There

is also the risk that fund managers may fail in their

payout and investment strategies, leading to

premature depletion of savings. At the same time, the

funds come without the added costs associated with

a guaranteed insurance product. 

As investment vehicles, payout funds are flexible and

portable. Investors can stop or start payments,

increase or decrease their investment, or liquidate

their interest entirely and invest in other assets—

although in taxable accounts there may be a taxable

gain or loss for such changes.

III. Guaranteed options 

Perhaps the best-known strategy for generating

guaranteed income in retirement is the immediate

income annuity. Yet immediate annuities are not

widely utilized, in part because savings in an income

annuity are illiquid. As a result, a new generation of

living benefit annuities is emerging. These products

offer annuity-like guaranteed income and access to

underlying assets, although with a quite different

profile of risks and costs.

Immediate income annuities

The traditional vehicle for insuring against longevity

risk is an immediate income annuity. An income

annuity is an insurance contract that typically provides

an income for life to either a single individual or two

individuals if survivor benefits are elected. 

The traditional fixed income annuity offers an income

fixed in nominal terms for life. However, annuity

contracts are also available in which the payout is

inflation-adjusted (the income starts at a lower level,

but grows with inflation over time) or is variable (the

income rises and falls over time depending on

underlying investment results).5

5 Our discussion here focuses on income annuities, which are used to generate monthly income, and not deferred annuities, which are used to generate income on

a tax-deferred basis. Deferred annuities are used widely in nonprofit retirement plans as well as by affluent households outside retirement plans seeking to

shelter investment income and capital gains from current taxation. 
10 > Vanguard Center for Retirement Research Volume 34

Annuities eliminate longevity risk through pooling

(Figure 8). In any given annuity pool, individuals have

varying life spans. Yet an insurance company can

predict with some certainty the average life

expectancy of a large pool of investors. In a simplified

example, imagine a pool consisting of three investors

with a collective life expectancy of age 86. In exchange

for loss of access to their savings, they are promised

a guaranteed lifetime income by the pool. Over time:

• Investor A lives only to age 76. The assets that

would have been used to fund Investor A’s income

until age 86 are instead reinvested in the pool upon

his death. 

• Investor B lives to age 86, the life expectancy of

the pool. In effect, his own savings (the return on

his invested capital less costs for the annuity pool)

fund his entire lifetime income. 

• Investor C lives to age 96. She receives the assets

she contributed, the net returns on those assets,

and the assets and returns from Investor A, who

died earlier than expected. 

The pooling of risk in an annuity allows for several

benefits. One is the ability to provide an income

guaranteed for life. A second is the ability to generate

higher income from a given set of retirement savings,

all other things being equal. Without risk pooling, all of

the investors in our example would have had to save

enough to self-insure their income through age 

96, the maximum life span in our example. With

annuity pooling, all investors can collectively base 

their income stream on a life expectancy of age 

86—knowing that, if they live longer, assets from

those who have died earlier will continue to fund

income payments. 

Finally, fixed and inflation-adjusted annuities provide

guaranteed income that does not fluctuate with

market conditions. Naturally, to cover the cost of

these guarantees with respect to longevity risk and

market fluctuations, insurers must add costs, typically

known as the mortality expense, within the annuity

contract. Some investors mistakenly view these costs

as superfluous investment charges, but they are not.

They are the costs of the guarantee against longevity

and market risks. 

Despite the potential benefits they provide, annuities

remain unpopular with investors. Within DB plans

offering a lump-sum option, the majority of participants

typically select a lump sum.6 Within DC plans, annuity

options are not widely available or frequently used.7

In the U.S. individual annuity market, only about $15

billion of assets were annuitized in 2006.8 This is in 

a retirement market with $3 trillion in IRAs and with

hundreds of billions of dollars in lump-sum distributions

flowing annually from retirement plans.

Figure 8. Annuity pooling of risk 

Source: Vanguard, 2008.

Investor A

Investor B

Investor C

$

$

$

Age 76

 Age 86

 Age 96

Annuity

pool

$$$$

$$$$$$$

$$$$$$$$$$$

6 See Vanguard, 2007, for a study of lump-sum versus annuity behavior in two Fortune 500 defined benefit plans. 

7 The Profit Sharing/401k Council of America (PSCA) reports that about one-fifth of DC plans offered an annuity distribution option (PSCA, 2007). Among Vanguard

recordkept plans, less than 5% of 401(k) and profit-sharing plans are estimated to offer an annuity payout option. 

8 See LIMRA, 2007.
Volume 34 Vanguard Center for Retirement Research > 11

9 This summary draws on Brown, Mitchell, Poterba, and Warshawsky (2001); Brown (2007); and Ameriks, Caplin, Laufer, and Van Nieuwerburgh (2008). 

10 In the case of annuities offered by private-sector DB plans, annuity payouts are typically guaranteed by the federal agency, the Pension Benefit Guaranty

Corporation (PBGC). However, the PBGC may not guarantee a retiree’s entire pension amount. In the case of annuities offered by a private insurer, a complete

bankruptcy by an insurer would be quite rare, although it has occurred. Private insurers are regulated at the state level, and policies are generally insured by

guaranty association funds supported by contributions from insurers in each state. However, the benefits from the guaranty funds could be frozen or delayed

pending the outcome of litigation surrounding a bankruptcy.

The preference for lump sums 

A substantial body of research has emerged that

examines why retirees do not make greater use 

of immediate income annuities.9 In fact, the lack 

of demand for annuities is sometimes referred 

to as the “annuity puzzle” in modern economics. 

One strand of annuity research is based on the

assumption that individuals are economically rational

agents in their preference for lump sums over

annuities. The arguments for a low demand for

annuities include: 

• Other annuity income. Investors already have

annuity income from Social Security or DB

pensions, and that may be all of the annuity

income they need. 

• Flexible spending. Individuals want flexibility as

well as regular income—flexibility to use their

savings to pay for unexpected living expenses.

Access to savings is important when they face

large, unexpected housing, transportation, or

health care costs, particularly long-term care

expenses. 

• Illiquidity and lack of control. Assets in an annuity

contract are transferred to the insurer and are

outside the investor’s control. Also, the purchase of

an annuity is typically irrevocable (except during an

initial cancellation period).The contract is essentially

illiquid and irreversible. (Some of these drawbacks

have been addressed by new and more flexible

products in the annuity market.)

• Bequests. Another motivation for retaining assets

in retirement is the desire to leave assets to heirs

and charities upon one’s death or to give gifts

during one’s lifetime.

In addition, annuities are subject to credit risk—the

chance that the annuity provider could fail to make

good on the contract’s promises.10 Traditional fixed

income annuities are also subject to inflation risk. 

Although inflation-adjusted and variable payout

annuities have emerged to address this concern, 

they are even less frequently used than traditional

fixed income annuities. 

The second strand of research, originating from 

a behavioral finance perspective, suggests that

psychological biases may cause individuals to

misperceive annuities. These include:

• Wealth illusion. Individuals may mistakenly

overvalue a large lump sum compared with 

a series of smaller income payments that are

guaranteed for life, even though the two are

equally valuable on a present value basis. 

• Misunderstanding of longevity risk. There is some

evidence that individuals misunderstand longevity

risk. They appear to overstate the risk of dying too

young and thus worry too much about the risk of

“forfeiting” their annuity investment to the

insurance company; and they underestimate the

risk of living a long life, and therefore undervalue

the benefits of longevity protection. 

• Financial illiteracy. Annuity contracts can be quite

complex and may be difficult for many individuals

to understand and interpret. Perhaps the demand

for annuities would rise with improved financial

education. A related issue is that annuities are

generally relatively expensive because of the cost

of the guarantee. Individuals may misperceive this

portion of the cost, failing to understand that it is

not a higher investment fee but an expense for 

the insurance element of the contract. 

If behavioral biases are the main issue, then perhaps

behavioral techniques such as reframing and default

arrangements might change investor demand for

annuities. Nonetheless, despite the range of

hypotheses on the issue, no single factor appears 

to fully explain why individuals have such a strong

preference for lump sums over annuities. 
12 > Vanguard Center for Retirement Research Volume 34

Living benefit annuities

The limited popularity of traditional annuities has led

insurers to create a new class of annuities providing

both guaranteed levels of income and flexible access

to savings. They are generally known as variable

annuities with lifetime or living benefits, and are often

referred to as guaranteed minimum income,

withdrawal, or lifetime benefit annuities. They also can

be described as hybrid annuities because they

combine the guaranteed element of an insurance

contract with the flexibility and control of an

investment account. 

The features of this type of annuity can vary

substantially. A typical contract would offer an

investment portfolio and a guaranteed income

stream (Figure 9). In such a contract, an individual’s

savings would be invested in a balanced fund. That

portfolio would be wrapped with an annuity contract

providing a guaranteed income for life, such as 5% 

of the initial amount invested. The income could 

grow over time with investment performance, 

but it would never decline.

For example, a 65-year-old retiree investing $100,000

in such a contract might initially receive $5,000 a year

for life. Over time, depending on the contract and

assuming buoyant financial markets, the guaranteed

lifetime income might “ratchet up” to higher levels—

$5,100, $5,300, and so on. This new income level is

then guaranteed for a lifetime.

Importantly, investors in such contracts have a benefit

unavailable in traditional annuities: the ability to

withdraw assets at their current fair market value. The

underlying fair market value of the contract will rise

and fall with investment results. But the balance is

always available for withdrawal, although sometimes

insurers impose surrender charges to discourage

redemptions.11

Despite their guarantee elements and flexibility, living

benefit contracts do have their limitations. First, fees

are quite high. Annual retail fees are typically on the

order of 2% to 3% or more. A portion of these fees is

required to finance the unique guarantee structure of

the products. However, a meaningful portion is also

related to marketing, distribution, and other costs.

Over time, lower cost versions are emerging for the

institutional marketplace. 

High fees pose a substantial hurdle for the

performance of living benefit annuity contracts. In a

low or modest return environment, high fees could

absorb a large percentage of future investment

returns. As a result, the contract’s value and the

11 If the investor does withdraw a portion of assets, the income paid by the contract declines on a pro rata basis. For example, if an investor withdraws 25% of

the market value of the account, the guaranteed income is adjusted downward by 25%. Some contracts may impose redemption or surrender charges as well

to discourage redemptions.

Figure 9. Example of hybrid annuity feature

Note: General characteristics of a variable annuity contract with a living benefit rider. 

Not intended to represent the actual features of any actual annuity contract.

Investor $100k

Balanced/

diversified

portfolio

Living benefit rider or “wrapper”

 Income (for example)

• $5,000 per year initially

• Lifetime guarantee

• “Ratchets up” with performance

 Assets

• Available at fair market value

 Price

• 200bp or more
Volume 34 Vanguard Center for Retirement Research > 13

income it generates might grow slowly—or not at

all—for an extended period. From the investor’s

perspective, what might have appeared to be an

investment offering guaranteed income and growth

could instead become a high-cost investment with

only guaranteed income and no growth. 

Second, it is difficult to assess these annuities’ longterm performance potential, given the variation in fee

levels and complex contractual features that exist

from provider to provider. Investors will struggle with

understanding whether the guaranteed elements are

delivering fair value relative to the fees being charged. 

A third issue is whether such contracts will actually 

be used to generate guaranteed retirement income.

In today’s market, living benefit features are quite

common in new deferred variable annuities, which 

are purchased mainly by affluent investors as an

accumulation-oriented investment. To date, the

contracts have not been widely used to pay

guaranteed income. In the worst case scenario, an

investor could purchase a high-cost contract for the

potential guarantee—but never use the guaranteed

income element, and so never receive a benefit for

the costs incurred. 

A final concern is the nature of the insurer’s skills 

and the level of capital backing the guarantees being

offered. Contracts with lifetime benefits are relatively

new, so few of the contracts are in the annuitization

or payout phase. They require careful hedging of stock

and bond market risks. In effect, investors in such

contracts are being offered a put option on future

stock and bond prices—in the event that markets

decline, investors receive income as if the market

losses hadn’t occurred. 

It is difficult for investors to know whether a given

insurer will be able to actually hedge the risks

accurately. If they fail to price them accurately, the

insurer may not maintain sufficient capital on hand

needed to back the contracts when stock and bond

markets fall. And if the hedging does go awry, how

will the insurance regulatory system—both state

regulators and the state guaranty funds—respond? 

In comparing the two “next generation” income

solutions—payout funds and hybrid living benefit

annuities—it seems clear that both pose risks to

investors. But the character of the underlying risk 

is quite different. 

• Payout funds are designed to be an off-the-shelf

SWP for investors who are unsure of how to set

up their own withdrawal program. Like other

investment products, they provide no guarantees

with respect to income or capital and expose

investors to underlying portfolio-related risks,

including the risk of spending from a portfolio 

in a declining market. In exchange, they provide

flexibility and liquidity. 

• The new generation of living benefit annuities

provides guaranteed income and flexible access to

savings—thus offering both liquidity and insurance

against market and longevity risks. However, high

costs may hinder their effectiveness, and the risk

always remains that insurers could fail in their

ability to support the complex guarantees. 

Other solutions 

Three other strategies may play a role in helping

retirees generate income. To date, however, the

market for these approaches remains underdeveloped.

Longevity insurance. Longevity insurance is an

annuity contract that pays a lifetime income only if 

the contract holder reaches an advanced age, such 

as 80 or 85. An investor deposits a lump sum with

the insurer at retirement, say at age 60 or 65. In

exchange, the insurer promises an income at age 

80 or 85—but no benefit if the investor dies earlier.

Longevity insurance has a certain intuitive appeal

because it provides an insurance policy for the one

element of risk—the risk of living too long—that

individuals cannot readily self-insure against. It has

been described as the “term insurance” of the 

spend-down phase—namely, an insurance contract

specifically targeted at the risk of living a long life. 

In practice, an investor might use an SWP or similar

strategy to manage assets through their life

expectancy and purchase longevity insurance against

the “long tail” risk of running out of savings at an

advanced age. 
14 > Vanguard Center for Retirement Research Volume 34

The question remains whether investors will actually

find longevity insurance appealing. The product

requires investors to be exceptionally long-sighted—

to forfeit their right to a portion of their savings at

retirement in exchange for a benefit that may

materialize in 20 or 25 years if they live a long life, 

or that will not materialize at all if they die sooner. 

This appears to pose a major behavioral obstacle 

to the adoption of these products.

Reverse mortgages. More than 80% of older

Americans own a home. In addition, despite the

recent turbulence in the housing market, home equity

represents a substantial portion of the total wealth of

the early wave of the baby boom generation. As a

result, policymakers and mortgage companies are

keenly interested in expanding the reverse mortgage

market as a source of retirement income. 

Reverse mortgages do not directly affect how

individuals manage their liquid financial savings in

retirement plans or personal accounts. But they do

have an indirect impact on such savings. Homeowners

who choose to receive guaranteed income from their

home equity may have a reduced need for regular

income streams from their liquid assets. 

In the typical reverse mortgage contract, the

homeowner can choose to receive a lump sum, 

a line of credit, a fixed monthly payment for a set

term or for as long as they live in the house, or some

combination of these methods. The loan is repaid

when the homeowners cease to occupy the house.

This generally occurs if the house is sold or if the

homeowners die. The loan balance is usually repaid 

by selling the home, although the loan can be repaid

by other assets if they are available. 

While in theory an attractive way to generate income,

the reverse mortgage market is immature and has

been hobbled by a number of concerns:

• Only a portion of equity is available. Retirees 

are able to extract only a portion of the home’s

equity—what has been referred to as “consumable

net worth.”12 For a typical new retiree, only half the

value of the equity may be accessible.13 In addition,

volatility in the housing market can impact the

amount of equity available to homeowners.

However, reverse mortgages have a “nonrecourse”

feature, so the amount owed cannot exceed the

appraised value of the house. Should the value of 

a house fall so low that the amount owed exceeds

the value, the lender would absorb the loss.

• Term-certain limits in some contracts. Some

reverse mortgage contracts do not provide a

lifetime income guarantee, but only an income for

a term certain, such as 30 years. Thus, they fail to

provide a full longevity guarantee. However, the

homeowner cannot be evicted from the home if he

or she outlives the term of the reverse mortgage.

The loan does not have to be repaid as long as the

homeowner lives in the house and keeps current

on taxes and insurance.

• Equity cannot be used for nursing home care.

There is evidence that home equity is used by older

Americans to pay for nursing home care or other

long-term care costs. By entering into a reverse

mortgage contract, homeowners diminish their

ability to use home equity in this way.

• Complexity and cost. The reverse mortgage

contract requires a settlement process that can be

daunting to some older investors, and the fees can

run as high as 10% of the principal loan amount.14

“DB in DC” annuities. A recent development in 

the retirement marketplace is the repackaging of

accumulation (or deferred) annuity contracts as

investment options for DC plans. In essence, with

each contribution into a DC savings plan, a participant

purchases both a current-day asset and a promised

level of income at retirement. Hence the term “DB 

in DC”—DC savings are being used to purchase

guaranteed lifetime annuities payable at retirement. 

Deferred annuity contracts may be offered as fixed

annuities (i.e., offering a stable principal value and a

fixed rate of return) or variable annuities (i.e., investing

12 Sinai and Souleles, 2007.

13 See Eschtruth, Sun, and Webb, 2006. 

14 See Fannie Mae, 2002, p.66. 
Volume 34 Vanguard Center for Retirement Research > 15

in equities, balanced funds, life-cycle funds, or similar

assets with a varying return and market value).

Besides offering exposure to a given asset class,

deferred annuities convert a participant’s current

balance in the contract into an income stream at

retirement, typically at age 65. Participants can also

defer payments until a later age to receive a higher

monthly income. In the typical DB-in-DC product, plan

participants see both their contract account balance

and a guaranteed level of future income on

statements and websites.

The merits and drawbacks of such contracts are

discussed in a separate Vanguard research note.15 

The main risk associated with such contracts is that

plan participants may pay for certain guarantees 

over extended periods, yet fail to exercise the lifetime

income feature. For example, a participant may spend

a career accumulating guaranteed income—only to

retire, take a lump sum, and decide not to annuitize.

Other considerations include fiduciary oversight within

retirement plans, fees, and portability.

IV. Implications 

The growing number of Americans retiring with lumpsum savings is driving interest in retirement income

strategies. The retirement income landscape is quite

varied. Nonguaranteed options for generating income

in retirement include income investing, SWPs, and

payout funds. Guaranteed options include immediate

income annuities and living benefit annuities, along

with less widely used strategies such as longevity

insurance and reverse mortgages. 

For individuals and advisors, the challenge does 

not appear to be a lack of strategies for managing

retirement income risks. Rather, the challenge

appears to be how to help individuals make informed

choices among the available options, and in particular

how to strike the right balance among guaranteed 

and nonguaranteed options in their portfolio. 

In short, an increasing number of individuals will need

a retirement income plan. Such a plan would combine

nonguaranteed and guaranteed elements, depending

on the trade-offs an investor is willing to make among

risk, return, and cost. At one extreme, the most riskaverse investor will seek some combination of

guaranteed options that protect fully against market

and longevity risks. At the other extreme, the more

risk-seeking investor will be satisfied with Social

Security as a sole source of guaranteed income and

will utilize nonguaranteed strategies like SWPs or

payout funds. Many households, we surmise, will

want a blend of options in their retirement income

plan. Advisors will need to respond by developing

methodologies for creating such plans for clients. 

Within DC plans, the main income options today are

typically systematic withdrawal features. Annuities are

infrequently offered, and even less frequently utilized

by participants. For plan sponsors and policymakers,

several other retirement income products are

emerging in the IRA marketplace as potential

alternatives. It remains to be seen, depending on 

the IRA experience, whether these strategies will 

be suitable as within-plan distribution options.

What seems clear is that the next generation of

retirees will have at its disposal an expanded set 

of choices for managing retirement income risks. 

Yet many of these options remain relatively new 

and untested. How will investors in portfolio-based

income approaches react in times of high market

volatility? Will the issuers of new guaranteed options

be able to hedge their risks effectively and be able to

keep their promises? These are the questions facing

the retirement income marketplace as it develops.

In this environment, the retirement income decision

for most individuals will come down to the same

principle that governed decisions in the accumulation

phase—the need to strike a careful balance between

risk, return, and cost. 

15 See Vanguard, 2008c.
References

Ameriks, John, Andrew Caplin, Steven Laufer, and

Stijn Van Nieuwerburgh, 2008. The Joy of Giving or

Assisted Living? Using Strategic Surveys to Separate

Bequest and Precautionary Motives. Available at the

Social Science Research Network:

www.ssrn.com/abstract=982674. 

Brown, Jeffrey R., Olivia S. Mitchell, James M.

Poterba, and Mark J. Warshawsky, 2001. The Role of

Annuity Markets in Financing Retirement. MIT Press,

Cambridge, MA. 

Brown, Jeffrey R, 2007. Rational and Behavioral

Perspectives on the Role of Annuities in Retirement

Planning. NBER Working Paper 13735. National

Bureau of Economic Research, Cambridge, MA.

www.nber.org. 

Eschtruth, Andrew D., Wei Sun, and Anthony Webb,

2006. Will Reverse Mortgages Rescue the Baby

Boomers? An Issue in Brief from the Center for

Retirement Research at Boston College. Number 54,

September. http://crr.bc.edu/. 

Fannie Mae, 2002. Money from Home: A Guide to

Understanding Reverse Mortgages. Fannie Mae,

Washington, D.C.

www.fanniemae.com/global/pdf/homebuyers/

moneyfromhome.pdf. 

LIMRA, 2007. The 2006 Individual Annuity Market:

Sales and Assets (2007). LIMRA International, Inc.

www.limra.com. 

PSCA, 2007. 50th Annual Survey: Reflecting 2006 Plan

Experience. 401(k)/Profit-Sharing Council of America,

Chicago, IL. www.psca.org.

Sinai, Todd M. and Nicholas S. Souleles, 2007. Net

Worth and Housing Equity in Retirement. FRB of

Philadelphia Working Paper No. 07-33.

www.ssrn.com. 

Vanguard, 2007. Lump Sum or Annuity? An Analysis of

Choice in DB Pension Payouts. Vanguard Center for

Retirement Research, Malvern, PA.

www.vanguard.com/retirementresearch.

Vanguard, 2008a. Generating Guaranteed Income:

Understanding Income Annuities. Vanguard

Investment Counseling and Research, Malvern, PA. 

Vanguard, 2008b. Immediate Income Annuities in

Defined Contribution Plans. Vanguard Center for

Retirement Research, Malvern, PA.

www.vanguard.com/retirementresearch.

Vanguard, 2008c. Research Note: ‘DB in DC’—

Deferred Annuities in Defined Contribution Plans.

Vanguard Center for Retirement Research, Malvern,

PA. www.vanguard.com/retirementresearch.

Vanguard, 2008d. Spending the Nest Egg: Retirement

Income Decisions Among Older Investors. Vanguard

Center for Retirement Research, Malvern, PA.

www.vanguard.com/retirementresearch. 

16 > Vanguard Center for Retirement Research Volume 34
Volume 34 Vanguard Center for Retirement Research > 17

For more information, visit www.vanguard.com, or call 800-523-1036 for Vanguard

funds and 800-522-5555 for Vanguard annuity products, to obtain fund and variable

annuity contract prospectuses. Investment objectives, risks, charges, expenses, and

other important information are contained in the prospectuses; read and consider them

carefully before investing.

The Managed Payout Funds are not guaranteed to achieve their investment objectives, are subject to loss, and some of their distributions may be treated

in part as a return of capital. The dollar amount of a fund’s monthly cash distributions could go up or down substantially from one year to the next and 

over time. It is also possible for a fund to suffer substantial investment losses and simultaneously experience additional asset reductions as a result of 

its distributions to shareholders under its managed distribution policy. An investment in a fund could lose money over short, intermediate, or even long

periods of time because each fund allocates its assets worldwide across different asset classes and investments with specific risk and return

characteristics. Diversification does not necessarily ensure a profit or protect against a loss in a declining market. The funds are proportionately subject 

to the risks associated with their underlying funds, which may invest in stocks (including stocks issued by REITs), bonds, cash, inflation-linked investments,

commodity-linked investments, long/short market neutral investments, and leveraged absolute return investments.

All investing is subject to risks. Investments in bond funds are subject to interest rate, credit, and inflation risk. Diversification does not ensure a 

profit or protect against a loss in a declining market. Foreign investing involves additional risks including currency fluctuations and political uncertainty. 

Variable annuities are long-term vehicles designed for retirement purposes and contain underlying investment portfolios that are subject to investment

risk, including possible loss of principal. Annuity guarantees are based on the claims-paying ability of the underlying insurance companies that issue the

annuity. Mutual funds and variable annuities are subject to risk. 

Past performance is not a guarantee of future returns.

All advisory services are provided by Vanguard Advisers, Inc. (VAI) a federally registered investment advisor and an affiliate 

of The Vanguard Group, Inc. (Vanguard).

Target Retirement Funds, target-date funds and balanced funds are subject to the risks associated with their underlying funds. Stocks of companies 

in emerging markets are generally more risky than stocks of companies in developed countries. All investments are subject to risk.
18 > Vanguard Center for Retirement Research Volume 34

Comparative information

Vanguard Managed Payout Funds Vanguard Lifetime Income Program Life-Only Fixed Annuity*

Objective Managed Payout Growth Focus Fund seeks to make To provide a fixed, guaranteed monthly payment for the

monthly distributions of cash while providing inflation life of the annuitant.

protection and capital appreciation over the long term. 

Managed Payout Growth and Distribution Focus Fund 

seeks to make monthly distributions of cash while 

providing inflation protection and capital preservation 

over the long term. 

Managed Payout Distribution Fund seeks to make monthly 

distributions of cash while providing capital preservation 

over the long term.

Payments Monthly; set each year based on a fund’s annual distribution Monthly; fixed unless you choose annual adjustments

rate and its average share price over the preceding three according to an inflation-based index or by a fixed percentage

years or since inception, whichever is shorter. rate selected at the time you purchase the annuity.

Costs and expenses Expense ratios as of May 5, 2008: No initial sales loads, charges, or surrender fees. Fees are

Growth Focus Fund: 0.58% incorporated into the rate quoted at the time of purchase.

Growth and Distribution Focus Fund: 0.58% Also see “Taxes” below.

Distribution Focus Fund: 0.57%

Liquidity You can redeem shares from these open-end mutual funds at None. You surrender any claim to principal in exchange for

any time. Any change in your share balance will affect your the annuity.

next monthly payout.

Guarantees and safety You receive no guarantees; payments and principal can go Payments are guaranteed based on the claims-paying ability 

up or down significantly. of the insurance company that issues the annuity.

Fluctuation of principal Share prices can fluctuate significantly. Not applicable because you surrender your principal.

Taxes Distributions may comprise any combination of income, Payments are generally treated as ordinary income. Annuities

capital gains, and return of capital. purchased with after-tax dollars will receive a partial return of 

capital in each payment. Some states may assess a one-time 

premium tax on annuity purchases.

* The life-only fixed annuity option of the Lifetime Income Program offers additional options such as period-certain, which provides payments for a predetermined

number of years in exchange for other considerations.

There may be other material differences between products that must be considered prior to investing.

Vanguard Institutional 

Investor Group

P.O. Box 2900

Valley Forge, PA 19482-2900

Connect with Vanguard® > www.vanguard.com/retirementresearch > vcrr@vanguard.com

© 2008 The Vanguard Group, Inc.

All rights reserved. Vanguard Marketing

Corporation, Distributor.

CRRRIL 122008

Contributors

John Friel

Vicky Hubert

Diane LeBold

Renee Rabito

Meg Shearer

Anita Smith
Authors

Gary R. Mottola

Stephen P. Utkus

The authors would like to

thank Anna Madamba and

John Ameriks for assistance

with the survey design and

for their helpful comments.

Spending the nest egg: Retirement income

decisions among older investors

Vanguard Center for Retirement Research October 2008

Volume 35

Executive summary. Our survey of older American investors (age 55–75 

with $50,000 or more in savings) reveals that half of retired households

tapped their long-term accounts in the past year, typically as a large, one-time

withdrawal. Only a small group of retirees is generating systematic payments

from long-term accounts. However, these patterns are likely to change as 

the number of older Americans seeking to generate regular income from

retirement lump sums increases.

Withdrawing assets. Half of retired households

withdrew assets from one or more of their

long-term savings or investment accounts in

the past year. Most withdrawals were taken

on a one-time basis, and they tended to be

large (half were more than $10,000), whether

or not the household had a traditional pension.

Withdrawals were used mostly for living

expenses and big-ticket purchases. However,

two in ten households spending from their

long-term accounts relied on some type of

systematic or regular income payment

program.

Multiple objectives. In thinking through

objectives for spending down their long-term

savings, many households pursue seemingly

conflicting goals. Most survey respondents

seek to have both a guaranteed monthly

income and protection of assets—while also

maintaining investment control, keeping up

with inflation, and having access to savings 

for unexpected expenses.

Spending strategies. Spenders use a variety

of strategies to guide their withdrawal

decisions from long-term accounts—from

basing withdrawals on living expenses (37%

of spenders), to using a regular dollar amount

(21%), spending investment income (16%), 

or using other rules of thumb. Other spenders

have no formal approach (21%) or use gut

feelings (10%). Less than one in ten appear to

have a formal spending rule in place. Meanwhile,

only 44% had a regular approach to reviewing

their spending strategy. 

Connect with Vanguard® > www.vanguard.com/retirementresearch > vcrr@vanguard.com
Financial complexity. The typical older-Americaninvestor household owns six distinct accounts; 

one-fifth hold ten or more accounts. In addition to

transaction accounts, one-third of older households

held three different types of long-term accounts

(IRAs, employer plans, and personal accounts), 

and 39% held two types. Furthermore, 94% of

respondents in our sample own a home, 48% 

were receiving a traditional pension, and another 

28% expected to receive one in the future.

The role of debt. About half of fully retired

households in our sample carried mortgage debt; half

carried credit card debt. Debt levels were higher among

those not yet retired (78% with mortgage debt, 64%

with credit card debt). In addition, households carrying

debt were much more likely to withdraw assets from

their long-term accounts in the past 12 months. 

Advice. More than nine in ten spenders relied on their

own judgment or their spouse’s assistance in making

spending decisions. Forty-two percent relied on

professional sources of advice, although most judged

advisors as only “somewhat” important in making

spending choices.

Implications. About one-half of retired households 

in our survey are tapping their long-term savings,

although most withdrawals are large and infrequent,

and only a few attempted to generate systematic

payouts. In light of the ongoing shift to lump-sum

payouts from retirement plans, our findings suggest

several implications.

First, an increasing number of individuals need help

translating an account balance into a regular income

stream. New investment and insurance products 

have emerged to help with this task. They may prove

especially valuable if they replace the relatively

intuitive approaches used by investors today with

systematic spending strategies.

Second, in terms of priorities, individuals rank

attributes of portfolio-based solutions (e.g. flexibility,

control) as highly as attributes of guaranteed solutions

(e.g., guaranteed monthly income). This suggests that

many investors would prefer a mix of retirement

income solutions, not a single approach, and need

help balancing these competing goals.

Third, complexity is quite common for many households

with long-term accounts. Helping individuals manage

that complexity, or possibly shift to simpler financial

situations, can be an important goal for education

programs and advisors.

Finally, education and advice programs will be

essential in helping investors derive regular income

from their long-term accounts. For many, a holistic

approach will be needed—combining a strategy for

spending down a specific account with related income

issues including Social Security, pensions, home equity,

and, for at least half of retirees, mortgage and credit

card debt.

2 > Vanguard Center for Retirement Research Volume 35
Background

Increasingly, older Americans working in the private

sector are receiving retirement plan benefits in the form

of a lump sum rather than a lifetime annuity. Driving

this development has been the growth of defined

contribution (DC) plans, an increase in the number 

of defined benefit (DB) plans offering a lump-sum

payout, and the expanded role of IRAs, which are

principally funded by rollovers from employer plans.

These developments have led to a growing interest 

in the spend-down, or retirement income, phase of

the savings life cycle. Yet little is known today about

how older Americans currently spend from their

accumulated savings. The goal of our current study 

is to develop a basic understanding of how older

Americans decide to spend assets in their long-term

savings and investment accounts—just before and 

in the early years of retirement.

The results in this report are based on a national online

panel survey of older Americans, age 55 to 75, with

$50,000 or more of accumulated financial assets. A

total of 1,478 respondents participated in the survey,

which was conducted in May 2008. Top-line survey

results have a +/– 3% sample error. Our methodology

is discussed further in the Appendix.

In this report, we begin by examining the 

frequency of withdrawals from long-term savings and

investment accounts, as well as the factors driving

those withdrawals. We then examine the broader

issue of financial complexity facing older households—

including the number and type of long-term accounts

held. We then examine the role of professional and

nonprofessional help. The report concludes with a

discussion of implications.

A note on terminology

Our survey respondent population might best be

described as “older American investors,” given their

age (55–75) and asset holdings ($50,000 or more). 

We use this term informally, but technically all of our

responses are at a household level, not an individual

level. Also, they are representative of households in

this age range with $50,000 or more in savings. We

estimate the survey to be representative of at least

one-half of older Americans in this age range, given

the savings threshold, but obviously not the entire

population of older Americans in this group.

Throughout this report we interchangeably use the

terms “withdrawals” and “spending.” However, our

survey asked respondents only about their withdrawal

behavior, not whether respondents actually spent the

money they withdrew. A reasonable assumption from

our findings is that, over time, most withdrawals are

eventually spent, since most respondents indicate

that they took withdrawals for daily or discretionary

living expenses, as well as “big-ticket” purchases. 

Incidence of withdrawals

Our respondents were asked whether they had

withdrawn any money from long-term savings and

investment accounts over the past year. They were

specifically asked about withdrawals from the

following types of accounts: 

• Employer accounts—any retirement or investment

account sponsored by an employer or held at the

workplace. 

• IRAs.

• Personal accounts—any other (generally taxable)

bank, brokerage, investment, or insurance account. 

We use the term “long-term accounts” to refer to the

three nontransaction accounts– employer, IRA, and

personal–and the term “retirement accounts” to refer

to IRAs and employer accounts.1

Volume 35 Vanguard Center for Retirement Research > 3

1 Our research focus is on liquid asset accounts. Illiquid holdings, such as business interests or investment real estate that are

typically held by only a fraction of affluent households, are incorporated in our analysis if the respondent included them in “personal

accounts” and assigned a value to them. 
Among those who reported being fully retired, 47%

indicated that they had taken at least one withdrawal

in the past year from any of their long-term accounts

(Figure 1). Among the partially retired, more than onethird reported taking a withdrawal from any long-term

account. In the entire sample, including those who

were retired, partially retired, and still working, about

one-third reported withdrawing money from any of

their long-term accounts.

Spending is also occurring among those not yet

retired. Twenty-seven percent of nonretired

respondents reported spending from their long-term

accounts sometime in the past year. One reason may

be that older workers are supplementing their current

resources with withdrawals from long-term accounts.

Another reason is that, because retirement is selfreported, respondents may view themselves as not

retired—even though they may have exited their fulltime occupation and are working at a lower income,

and thus need to take withdrawals from their savings.

Why are older American investors tapping their 

long-term accounts? The main reason is to pay for

daily living expenses, cited by 44% of those withdrawing from personal accounts, 48% of those

withdrawing from employer plans, and 43% of those

withdrawing from IRAs (Figure 2 on page 5). Paying

for discretionary expenses (such as leisure and

entertainment) is also important. Big-ticket

expenditures (e.g., housing, cars, appliances)

accounted for a smaller but still-significant percentage

of those making withdrawals (22% to 39%, depending

on the type of account withdrawn from).

Under U.S. tax law, owners of IRAs and employer

retirement accounts must take required minimum

distributions (RMDs) once they turn age 701

⁄2. Since

our survey population included individuals up to age

75, some respondents taking withdrawals cited

RMDs as the reason for withdrawing from employer

and IRA accounts. The incidence of RMD-driven

withdrawals was more common for IRAs than for

employer accounts because, on average, IRA holders

in our survey were older than the respondents with

employer plans.

Who is spending?

In an attempt to better understand the factors that

drive the withdrawal decision, we conducted a

regression analysis that examined the relationship

between a host of demographic variables and the

decision to spend assets from long-term accounts

over the past year.2

The main factors influencing the decision to spend are

being older and being retired (Figure 3 on page 5).

Investors that were ten years older were 11% more

likely to make a withdrawal (versus a base withdrawal

rate of 34%); being retired raised the probability of

spending by 10%.

Does the presence of a traditional pension influence

spending from long-term accounts? In our analysis, 

it did not. Forty-eight percent of our sample reported

they were currently receiving a pension, and another

28% expected to receive one in the future.3 In our

regression analysis, there was no link between

receipt of a current pension, our “pension” variable,

and the probability of spending from long-term

accounts in the past year.

4 > Vanguard Center for Retirement Research Volume 35

Figure 1. Incidence of Withdrawals 

In Past 12 Months

0

60%

Percentage withdrawing

47%

32% 35%

21%

27%

12%

36%

21%

Fully

retired

Partially

retired

Not

retired

All

Source: Vanguard, 2008

Any long-term account Employer or IRA account only

2 Our model is a logistic regression relating the presence of a withdrawal from a long-term account in the past 12 months to a variety

of demographic variables. We report here only marginal effects. Complete regression results are available from the authors.

3 Our pension coverage estimate may appear high. Purcell (2008) reports that, in our age ranges, 9-15% of households are currently

receiving a public pension and 12-30% are receiving a private pension. Assuming no overlap between private and public pension

coverage, no more than 45% of households in these age ranges are currently receiving a DB pension benefit. Our higher figure

may reflect the greater affluence of our survey population, the failure of respondents to understand their pension eligibility, or a

confusion between DB and DC plans.
Volume 35 Vanguard Center for Retirement Research > 5

Figure 2. Reasons for Withdrawals for Spending Households

0

60%

50

30

20

40

10

Personal Employer IRA

Note: RMDs are required minimum distributions from IRAs or employer plans after age 70 . 

Source: Vanguard, 2008. 

Daily living 

expenses

Discretionary

expenses

“Big-ticket”

purchases

Other

investments

College

expenses

RMDs IRA

rollover

Other Not sure

Percentage of respondents making withdrawals

2 1

/

Figure 3. Factors Influencing Withdrawals 

Among those spending from long-term accounts 

Note: * Indicates variable significant at .05 level.

Source: Vanguard, 2008.

–5

20%

0

Mortgage* Household age

(10)*

Retired* Credit card

debt*

Assets high* Children

at home

Pension Household

health

Income high

Percentage change in probability of withdrawing assets

14%

11%

10% 11%

4%

3%

0% –2%

8%
In our sample, 49% of retired households reported

carrying credit card debt and 50% reporting having 

a mortgage (compared with 64% and 78% for

nonretired households). What is striking is the role

played by mortgage and credit card debt in influencing

the spending decision between ages 55 and 75.

Mortgage holders were 14% more likely to withdraw

assets from their accounts relative to nonmortgage

holders—that is the equivalent of a 41% increase 

on our base withdrawal rate of 34%. In addition to

mortgage debt, households with credit card debt

were 11% more likely to tap their accounts than

households without credit card debt.

We return to the issue of debt management in

retirement later in this report.

Motivation for strategy

Those respondents spending from long-term accounts

reported attempting to balance a wide range of goals,

many of which can be conflicting. In terms of factors

perceived to be “very important” or “somewhat

important” in setting a spending strategy, older

American investors cited a range of considerations:

ensuring that money lasts, paying for basic living

expenses, retaining control over assets, having a

guaranteed income, and keeping up with inflation,

among others (Figure 4). 

Yet in reality, assets that provide a regular or

guaranteed income (e.g., fixed income securities,

fixed annuities) also are often subject to inflation risk,

while assets that provide protection against premature

liquidation of assets (e.g., income annuities) can entail

loss of control and loss of flexibility. Similarly, assets

offering control and flexibility, such as portfolio-based

withdrawals, do not necessarily provide guaranteed

income and asset protection.

Additionally, more than 80% of respondents cited

eight different factors as being “somewhat

important” or “very important” to their spending

decisions. These results underscore the challenge 

of helping households make appropriate trade-offs

among competing priorities. It also suggests that

households may need a holistic or blended approach

to retirement income solutions. Rather than simply

choosing portfolio-based income solutions or

guaranteed options, households may prefer a mix 

of strategies.

6 > Vanguard Center for Retirement Research Volume 35

Source: Vanguard, 2008.

0

100%

Keeping

control

Ensuring my

money lasts

Protecting

assets

Keeping 

up with

inflation

Unexpected

expenditures

Guaranteed

income

Basic 

living

expenditures

Regular

monthly

income

Leaving

inheritance

Charitable

giving

Percentage somewhat or very important

96% 95% 92% 93%

85% 85%

59%

50%

82%

90%

29% 23%

39%

33%

30%

16%

41%

39%

27% 41%

67% 72%

53%

60%

55%

69%

18% 11%

49% 55%

Figure 4. Motivation for Withdrawal Decisions 

Among those spending from long-term accounts

Very important Somewhat important
Volume 35 Vanguard Center for Retirement Research > 7

The only factors that did not appear to be universally

important were bequest motives. Eighteen percent of

respondents mentioned bequeathing assets to heirs

as “very important” and 11% cited bequeathing

assets to charities as “very important.” Even among

households with more than $1 million in assets, the

percentages increased to 19% for heirs and 15% for

charities. However, the proportion considering these

goals important rose to about six in ten households

when “somewhat important” and “very important”

responses are included together. Thus, while not a

primary goal, respondents appear interested in

bequeathing assets should their financial situation

allow it. In a sense, bequests are a residual goal for

many households, even the more affluent.

Spending patterns

The types of spending strategies used by investors

varied according to the type of account from which

they were withdrawing. IRAs and employer plans had

the same pattern of spending approaches (Figure 5).

The most common approach was a single withdrawal 

in the past 12 months, used by approximately six in

ten investors spending from their IRAs or employer

accounts. The second most common strategy, used

by roughly one-quarter of spenders from these

accounts, was an installment or systematic

withdrawal plan. Ad hoc withdrawals (meaning more

than one withdrawal in the past year, but with no set

schedule) were also reasonably common among

about one-fifth of those spending from IRAs or

employer plans.

For personal accounts—which are more often taxable

investment or savings accounts—the pattern of

withdrawal strategies was different. About one-half 

of spenders took a single withdrawal, and four in ten

favored an ad hoc approach. None of our respondents

reported using an installment payment on these

accounts, but 16% indicated they withdrew only

dividend and interest payments—most likely driven 

in part by an effort to control the realization of capital

gains taxes.

Given the emphasis on one-time withdrawals, most

withdrawals were large in dollar terms. About 50% of

withdrawals during the past 12 months were for more

than $10,000, and about 20% were for more than

$25,000 (Figure 6 on page 9).

49%

0%

16%

40%

62%

23%

4%

17%

57%

27%

4%

21%

IRA Employer account Personal account

Figure 5. Withdrawal Frequency by Account Type 

Among those spending from long-term accounts

0

80%

Source: Vanguard, 2008. 

One single withdrawal Regular installment payments

Dividend and interest payments Ad hoc basis

Percentage of respondents withdrawing
Somewhat surprisingly among our respondents, these

withdrawal patterns were not affected by traditional

pension coverage. Households making withdrawals

took large, infrequent withdrawals regardless of

whether they were receiving regular monthly income

from a pension. Households without a traditional

pension did not appear to replicate monthly 

payments through greater use of installments.

The fact that withdrawal patterns are unaffected 

by the presence of traditional pensions could be

explained by several factors. Households may face

financial literacy constraints and may not know how 

to create a regular income stream from a long-term

account. Households may also be slowly spending

from their transaction accounts, not from their longterm savings.

Withdrawal strategies

There was no dominant respondent strategy for

spending from long-term accounts (Figure 7 on page 9).

The most common strategy, cited by 37% of spenders,

was to base withdrawals from long-term accounts on

the amount they needed for current living expenses.

Other respondents set their withdrawals based on 

a specific dollar amount (21% of spenders), a rule 

of thumb they had developed (20%), or investment

income (16%). Fewer respondents used percentage

rules (9%) or some type of formal spending rule (6%). 

A minority of respondents used intuitive or

unstructured approaches. These included having 

no formal strategy for how to spend-down savings

(21% of spenders) or gut feeling (10%).

While many strategies appear to be structured, it’s

impossible to derive from our survey whether these

rules were designed to help mitigate longevity risk

(the risk of living a long life and prematurely depleting

resources). For example, basing withdrawals on

current living expenses appears to be inattentive to

longevity risk. A longevity-risk-sensitive approach

would base withdrawals on how long a portfolio 

might last, not on what an individual needs for living

expenses. Similarly, the dollar or percentage rules

used by some could be set too high (leading to a

premature depletion of savings) or too low (leading 

to too little spending in retirement).4

However, what does emerge from our survey is a

dichotomy between the strategies used by older

American investors and the techniques recommended

by financial planners and advisors. Such formal

strategies include spending policies such as the 

so-called 4% rule.5 While some of our respondents

may be following such a program, most are not.

The frequency with which spenders review their

approach alludes to the informal nature of their

withdrawal strategies. Forty-four percent of spenders

reported reviewing their spending approach regularly,

while 56% did so with no set schedule, very

infrequently, or not at all (Figure 8 on page 10).

Account complexity

For older American investors, the decision of how to

spend savings in retirement takes place in the context

of a specific structure of individual accounts. The

complexity of those accounts—and thus of the

decisions facing investors—varies considerably. 

Our respondents were asked about the number of

total accounts they held—long-term accounts such 

as employer plans, IRAs, or personal accounts, as

well as the number of transaction accounts (such 

as checking or money market accounts) used to 

pay routine bills.

Forty-five percent of households in our survey held

fewer than six total accounts, while 43% held more

than six (Figure 9 on page 11). At one extreme, about

one-fifth (21%) of households had a relatively simple

account structure, with three or fewer accounts; 

at the other, about one-fifth (18%) owned ten or

more accounts.6

8 > Vanguard Center for Retirement Research Volume 35

4 See Vanguard, 2008a, for an in-depth discussion of longevity risk.

5 With the 4% rule, an investor spends 4% of total portfolio assets in the first year of retirement—and then adjusts the dollar amount

in each future year by the rate of inflation.

6 We believe our estimate has a downward bias because some respondents may have conflated financial accounts with financial

relationships. For example, if they had two IRAs at a financial institution they may have responded that they have one account.
Volume 35 Vanguard Center for Retirement Research > 9

<$1,000 $1,000–$2,499 $2,500–$4,900 $5,000–$9,999 $10,000–$24,499 >$25,000

Figure 6. Dollar Value of Withdrawal by Account Type 

Among those spending from long-term accounts

0

25

20

15

10

30%

Source: Vanguard, 2008. 

Percentage withdrawing

IRA Employer plan Personal

37%

21%

20%

16%

9%

6%

2%

21%

10%

4%

Required

living

expenses

Regular

dollar

amount

Rule of

thumb

Investment

income

Regular

percentage 

Formal

spending

rule

Another

strategy

No formal

strategy

Gut

feeling

Not sure

Figure 7. Withdrawal Strategies 

Among those spending from long-term accounts

0

40%

Note: Multiple strategies possible.

Source: Vanguard, 2008. 

Percentage of spenders using strategy
The level of complexity is even greater because of the

types of accounts households own. Nine of ten older

American households in our sample held a transaction

account, with the average number of accounts held

being close to two (Figure 10 on page 11). Eight of

ten owned personal accounts, holding nearly 3

accounts on average. Approximately seven of ten

owned IRAs (2.5 on average), and six of ten had

employer accounts (just fewer than two on average).

Different households held varying combinations of

these accounts, further adding to complexity (Figure

11 on page 12). About one-third (32%) of households

in our survey held accounts of all four types: transaction,

IRA, employer, and personal. On average, those

households had ten distinct accounts. Another 39%

held a transaction account or accounts along with two

other types of long-term accounts (i.e., personal and

IRA, IRA and employer, or personal and employer). 

In other words, seven of ten respondents face a

reasonably complex account structure. At the other

extreme, three of ten respondents only held one or

two account types, with a relatively modest number

of accounts.

Besides the complexity of long-term accounts, older

investor households must consider other elements of

their financial situation: 

• 94% own a home, and home equity can be used 

in a variety of ways in retirement (for bequests, 

for nursing home costs, for regular income).

• 48% of households surveyed are currently

receiving an employer pension. And an additional

28% are expected to receive a pension in the future.

Furthermore, nearly all households are eligible for

Social Security benefits. For many investors, these

assets and income streams add another layer of

complexity onto an already complex financial situation. 

Who faces the greatest complexity? 

We completed a regression analysis relating various

demographic factors to account complexity.7 For the

purposes of this analysis, we categorize households

with all four types of accounts (transaction, IRA,

employer, and personal) as having a complex account

structure; all other households were classified as 

not complex. 

All things being equal, households with more than

$250,000 in assets are 23% more likely than

households with less than $250,000 in assets to have

complex account structures (Figure 12 on page 12). 

To put this in perspective, 32% of households in 

our sample have complex account structures, so a

23% increase over a base of 32% is a relative

increase of 72%.

In addition, households with incomes of more than

$100,000 are 12% more likely to have complex account

structures relative to households with incomes of less

than $100,000. Conversely, older and retired households,

as well as households carrying debt, are less likely to

have complex structures.

These results suggest that households may be

simplifying their accounts as they grow older. At the

same time, the greater complexity of accounts among

those in their 50s versus those in their 70s in our

sample may be due to the greater prevalence of

employer-sponsored DC accounts among younger

households.

10 > Vanguard Center for Retirement Research Volume 35

Source: Vanguard, 2008.

 49% No set schedule

 7% Never or very infrequently

 44% Regularly

Figure 8. Frequency of Review

Among those spending from long-term accounts

7 Our model is a logistic regression relating account complexity to a variety of demographic variables. We report here only marginal effects. Complete regression

results are available from the authors. 
Volume 35 Vanguard Center for Retirement Research > 11

Figure 9. Number of Accounts

Including both transaction and long-term accounts Percentage of participants

0

5

10

15%

Median = 6.0 

Mean = 6.7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 or

more

Number of accounts

Source: Vanguard, 2008. 

Percentage owning (left axis)

Mean number of accounts (right axis)

0

100%

Figure 10. Types of Accounts

0

1

2

3

Transaction 

accounts

Personal 

accounts

IRAs Employer 

accounts

91%

79%

68%

57%

Source: Vanguard, 2008.
12 > Vanguard Center for Retirement Research Volume 35

32%

22%

10%

7%

9%

4%

16%

0

35%

Transaction, IRA,

Employer, & 

Personal

Transaction, 

IRA, & 

Personal

Transaction,

Employer, & 

Personal

Transaction, 

IRA, & 

Employer

Transaction 

& Personal

Transaction 

& Employer

Other account

combinations

0

12

Percent Owning (left axis) Mean Number of Accounts (right axis)

Source: Vanguard, 2008.

Figure 11. Account Combinations

6

% change in proability of having a complex account structure

–30

0

30%

23%

Assets > 250K*

12%

Income >

100K*

9%

Pension*

0%

Children

at home

–2%

Household

health

–9%

Mortgage*

–14%

Retired*

–16%

Credit card

debt*

–18%

Household age

(10)*

Note: * Indicates variable significant at .05 level.

Source: Vanguard, 2008.

Figure 12. Factors Related to Complex Account Structures
Volume 35 Vanguard Center for Retirement Research > 13

Mortgage and credit card debt

Mortgage and credit card debt add another layer 

of complexity to spending decisions at or near

retirement. Sixty-three percent of the households 

in our sample still carried a mortgage, although that

figure dropped to 50% for fully retired households

(Figure 13). Thirty percent of households surveyed 

had a mortgage balance of more than $100,000.

Similarly, 56% of all households and 49% of retired

households carry credit card debt. Of the total

households surveyed, 23% had more than $5,000 

in debt and 12% had more than $10,000. Households

with credit card debt have about the same household

income as households without credit card debt, but

they have lower asset levels. Furthermore, households

with credit card debt are more likely to have children

living at home and to carry a mortgage.

As noted earlier (Figure 3), debt burdens may

contribute to older American investors tapping their

long-term accounts earlier than debt-free households

do. There are a couple explanations why debt and

withdrawal behavior may be linked:

• As they approach retirement, older Americans are

making withdrawals from savings in an effort to

pay down debt levels.

• Some older households need to withdraw from

savings to service their mortgage or credit card

debt.

In any event, what is evident from the data is that 

for a large group of older Americans, all of whom

have accumulated at least $50,000 in savings, the

retirement income question is not solely about how 

to spend down those savings; it is also about 

how to manage mortgage and credit card debt.

The role of advice

Creating a retirement income strategy can be difficult.

Investors need to analyze their income sources, asset

holdings, debts, preferences for liquid versus

annuitized wealth, current and projected future living

expenses (including large out-of-pocket costs for

health care), and their interest in bequests and

charitable giving. And all of this needs to be

considered in light of the features of federal and

private benefit programs, the capital markets, taxes,

and the range of investment and insurance products

available to help manage retirement risks. Given the

difficulties involved, it’s not surprising that individuals

might seek professional advice.

However, our respondents indicated that they rely

primarily on themselves or their spouses for making

spending decisions from their portfolios (Figure 14 

on page 14). Virtually all respondents cited their own

or spouse’s role as “very important” or “somewhat

important” in making spending choices. Forty percent

cited an advisor, financial planner, or broker, and

another 18% mentioned help from an accountant.

Given the complexity of the income issues, what is

notable is that few advisors, brokers, planners, or

accountants are viewed as “very important” in the

spending process—only 14% in the case of advisors,

brokers, or planners, and 6% in the case of

accountants.

Figure 13. Mortgage and Credit Card Debt 

by Retirement Status

Fully Partially Not

All retired retired retired

Mortgage debt

Percent holding 63% 50% 67% 78%

% with over 100k

on mortgage 30% 25% 29% 38%

Credit card debt

Percent holding 56% 49% 57% 64%

% with over 5k in debt 23% 15% 26% 34%

Source: Vanguard, 2008.
14 > Vanguard Center for Retirement Research Volume 35

These statistics, however, may understate the

importance of advice because it looks at each advice

provider in isolation. For a broader view, we segmented

sources of advice into professional and nonprofessional

advice categories—the former including advisors,

brokers, planners, and accountants; and the latter

including friends, relatives, the financial media, and

financial websites. We also compared the attitudes 

of those already spending from their accounts with

those not yet spending.

When aggregated in this fashion, advice does take 

on a somewhat more prominent role among the

spenders (Figure 15 on page 15). Twenty-five percent

cite any type of nonprofessional help as important,

42% cite any type of professional help as important,

and more than half cite any type of help as important.

A much higher percentage of respondents not yet

spending from their accounts cited advice as being

important. Depending on the form of advice, oneand-a-half to two times the number of nonspending

respondents mentioned advice as important relative

to those already spending. There are no meaningful

demographic differences between households that

cited advice as important and those that did not.

Implications 

Given the long-term decline in traditional DB pensions,

and the growth of DC plans and IRAs, there is growing

interest in the issue of retirement income—how older

households will translate lump-sum savings into a

regular payment stream. 

One of the striking findings of our survey is that 

many households in our survey sample (age 55–75

with savings of $50,000 or more) do not create regular

income streams from long-term accounts—a finding

that is true of both households with and without

traditional pension income. Instead, when they spend

from their accounts, the withdrawals tend to be large

and infrequent. In addition, the approach many use for

withdrawing money appears unstructured or

unsophisticated. 

As households seek to generate regular income

streams from lump sums, our findings suggest

0

100%

Very Important Somewhat Important

Source: Vanguard, 2008.

Percentage somewhat or very important

89%

67%

14%

6% 6% 4% 3% 3%

8%

25%

26%

12% 10% 10% 9% 6%

Myself Spouse Adviser, 

planner, 

broker

Accountant Relatives Financial

Websites

Media Friends

97%

92%

40%

18% 16% 14% 12% 9%

Figure 14. Importance of Source for Spending Advice 

Among those spending from long-term accounts
Figure 15. Professional versus Non-Professional Help

Percentage citing source of advice as "somewhat" or "very" important

Non-professional Professional Non-professional AND Non-professional AND/OR

help help professional help professional help

By withdrawal status

Have already withdrawn from accounts 25% 42% 16% 51%

Have not yet withdrawn from accounts 53% 70% 40% 83%

Source: Vanguard 2008.

Volume 35 Vanguard Center for Retirement Research > 15

several important implications for the future. First,

individuals are likely to need more help structuring

regular income streams from their long-term accounts.

Already, among those spending from their long-term

accounts today, about one-fifth reported using some

type of systematic spending rule or strategy for

generating income. This proportion will only increase 

in the future.

There will be an increase in demand for insurance 

and investment products that help investors translate

a lump sum into an income stream. It seems that

many future retirees could benefit from products that

replace today’s relatively intuitive or unsophisticated

strategies with a more structured approach to

generating income.

Second, it is evident that investors have no specific

preference for portfolio-based income solutions over

guaranteed ones, or vice versa. Rather, they would

like to simultaneously pursue attributes associated

with portfolio solutions (flexibility, control, growth

above inflation) with guaranteed elements (regular

monthly income, longevity protection). Helping

investors make suitable trade-offs among these goals

will be important. It also seems that many investors

would prefer a blend of strategies, rather than a single

approach, as they plan their retirement income needs. 

Third, complexity is quite common for many

households. Complexity is a function of the number of

accounts plus the varying type of accounts. It is also a

function of related retirement income issues—Social

Security, pensions, home equity, and for half of our

respondents, managing mortgage and credit card

debt in retirement. Helping individuals manage that

complexity, and helping them shift when possible to

simpler financial situations, appears to be an essential

aspect of the retirement income process. 

Finally, it is clear that education and advice programs

on retirement income will become increasingly

important. Investors face the challenge of converting

a given account balance into an income stream, but

they need to address this challenge in a holistic

fashion. More specifically, investors need to consider

how a decision about a specific account relates to

broader retirement income issues involving Social

Security, pensions, and debt management, among

other issues. Workplace and retail financial education

programs will be increasingly important in addressing

this challenge, as will financial advisors, planners, and

accountants.

The baby boom generation is heading inexorably

toward retirement, and many of its members will

have lump-sum savings in hand. As our findings

highlight, many investors with accumulated savings

still have regular payments from DB pensions as a

source of retirement income. However, as the

importance of such income streams declines, many

older Americans will look to other strategies for

converting a lump-sum account into a regular income

stream. Our current findings suggest how individuals

manage that task today. Future research could examine

the rationale and the effectiveness of various withdrawal

strategies, as well as how aging households manage

mortgage and credit card debt into retirement.
16 > Vanguard Center for Retirement Research Volume 35

Appendix: Methodology and 

sample description

This study is based on a national panel survey of older

Americans, age 55 to 75, with $50,000 or more of

accumulated retirement savings. A total of 1,478

respondents participated in the survey, which was

conducted in May 2008 by Greenfield Online. For

proportions summarizing the entire sample, the

sampling error is +/–3% at the 95% confidence level.

However, the error can be larger when we report

statistics based on smaller subsamples.

This respondent population, whom we refer to as

“older American investors,” is likely representative of

at least half of older Americans age 55–75. Because

we are considering how older Americans with financial

assets liquidate their savings, our survey population

necessarily excludes older Americans with smaller (or

no) levels of financial assets. Also, because we are

most interested in the impact of recent plan design

changes, we exclude older Americans older than 75 

in an effort to focus on those approaching retirement

or recent retirees.

Summary statistics on the survey respondents can be

found in the accompanying table (Figure 16 on pages

17 and 18). Our typical respondent is married, age 62,

with a household income between $75,000 and

$99,999 and total financial savings between $100,000

and $250,000. Compared with national census data,

our respondent households are necessarily more

affluent than the typical household in this age range—

no doubt because we excluded households with less

than $50,000 in savings. Twenty-nine percent of the

households report that they are fully retired, 35% are

partially retired, and 32% are not retired.

References

Purcell, Patrick, 2008. “Income and Poverty Among

Older Americans in 2007.” Congressional Research

Service, The Library of Congress, Washington, D.C.

Vanguard, 2008a. “Generating Guaranteed Income:

Understanding Income Annuities.” Vanguard

Investment Counseling & Research, Malvern, PA.

Vanguard, 2008b. “Immediate Income Annuities and

Defined Contribution Plans.” Vanguard Center for

Retirement Research, Malvern, PA.

Vanguard, 2008c. “DB in DC: Deferred Annuities in

Defined Contribution Plans.” Vanguard Center for

Retirement Research, Malvern, PA.
Volume 35 Vanguard Center for Retirement Research > 17

Figure 16. Demographics of Survey Respondents

Respondents Age 55–75 with at least $50,000 in assets (n=1,478)

Age 

55–59 34%

60–64 26%

65–69 20%

70–75 20%

Total 100%

Gender

Male 50%

Female 50%

Total 100%

Education

Did not finish high school 0%

High school graduate 19%

Two-year college 22%

Four-year college 24%

Some graduate/professional school 12%

Graduate/professional degree 23%

Total 100%

DB pension benefits

Currently receiving 48%

Expect to receive 28%

Total 76%

Credit Card Debt

None 43%

Less than $500 9%

$500 to less than $2,500 14%

$2,500 to less than $5,000 9%

$5,000 to less than $10,000 11%

$10,000 and over 12%

Not sure 2%

Total 100%

Home Market Value

I/we don’t own a home 5%

Less than $50,000 0%

$50,000 to less than $100,000 4%

$100,000 to less than $250,000 35%

$250,000 to less than $500,000 35%

$500,000 to less than $1,000,000 16%

$1 million to less than $2 million 3%

$2 million and over 1%

Not sure 1%

Total 100%

Assets

Less than $50,000 0%

$50,000 to less than $100,000 24%

$100,000 to less than $250,000 26%

$250,000 to less than $500,000 22%

$500,000 to less than $750,000 11%

$750,000 to less than $1,000,000 7%

$1 million to less than $2 million 8%

$2 million and over 2%

Not sure 0%

Total 100%

Household Income

Less than $20,000 0%

$20,000 to $29,999 0%

$30,000 to $39,999 1%

$40,000 to $49,999 3%

$50,000 to $59,999 17%

$60,000 to $74,999 24%

$75,000 to $99,999 26%

$100,000 to $199,999 24%

$200,000 to $299,999 3%

$300,000 and over 1%

Not sure 1%

Total 100%
18 > Vanguard Center for Retirement Research Volume 35

Figure 16. Demographics of Survey Respondents

(Continued)

Respondents Age 55–75 with at least $50,000 in assets (n=1,478)

Work / retirement status

Fully retired 29%

Partially retired 35%

Not retired, still working 32%

Other 4%

Total 100%

Mortgage

I/we have no mortgage 37%

Less than $50,000 14%

$50,000 to less than $100,000 18%

$100,000 to less than $250,000 22%

$250,000 to less than $500,000 6%

$500,000 to less than $1,000,000 1%

Over $ 1 million 0%

Not sure 1%

100%

Transaction Account Balances

Less than $500 4%

$500 to less than $1,000 9%

$1,000 to less than $2,500 21%

$2,500 to less than $5,000 25%

$5,000 to less than $10,000 16%

$10,000 and over 22%

Not sure 3%

Total 100%

Work-related Account Balances

Less than $25,000 9%

$25,000 to less than $50,000 12%

$50,000 to less than $100,000 20%

$100,000 to less than $250,000 28%

$250,000 to less than $500,000 14%

$500,000 and over 10%

Not sure 7%

Total 100%

IRA Account Balances

Less than $25,000 13%

$25,000 to less than $50,000 13%

$50,000 to less than $100,000 20%

$100,000 to less than $250,000 25%

$250,000 to less than $500,000 15%

$500,000 and over 10%

Not sure 4%

Total 100%

Personal Account Balances

Less than $25,000 16%

$25,000 to less than $50,000 16%

$50,000 to less than $100,000 18%

$100,000 to less than $250,000 21%

$250,000 to less than $500,000 14%

$500,000 and over 10%

Not sure 5%

Total 100%
Vanguard Institutional 

Investor Group

P.O. Box 2900

Valley Forge, PA 19482-2900

Connect with Vanguard® > www.vanguard.com/retirementresearch > vcrr@vanguard.com

© 2008 The Vanguard Group, Inc.

All rights reserved. 

CRRSNE 102008

Contributors

Kathy Berardi

Laurie Doyle

Vicky Hubert

John Friel

Christine Johnson

Wayne Moser