Retirees who watched in horror as their account balances plunged along with the stock market now face a new challenge: how to generate enough income to pay their bills.
A widely accepted rule of thumb suggests that if you hold initial withdrawals to 4% of your nest egg during the first year of retirement and increase that dollar amount by 3% in each of the following years to keep up with inflation, you won’t run out of money over a 30-year retirement. Now even that strategy may not be cautious enough, and you may have to rethink your plans for retirement income.
Depending on the extent of your losses, you may want to freeze your withdrawals at current levels, skipping the annual inflation adjustment until the market rebounds. Or, if you suffered significant losses of 30% or more, you may want to restart your 4% withdrawal schedule based on the new, lower balance. But that can take a big bite out of your income. Say you started with a $1-million retirement stash and had been withdrawing more than $40,000 a year. If your savings shriveled to $700,000, you’d now have to get by on just $28,000 a year.
There is, however, another way to stretch your income and increase your annual withdrawals to 8% or more of your savings. And you can still be assured you won’t outlive your money. A study by the University of Pennsylvania’s Wharton Financial Institutions Center found that by purchasing an immediate annuity, you could create a stream of secure lifetime income for 25% to 40% less than it would take to generate the same income from a traditional portfolio of stocks, bonds and cash using the 4% withdrawal rule. (That’s because with an annuity, you’re tapping both your principal and your earnings as well as pooling your risk with other annuity owners.)
Say you’re a 65-year-old man with a $1-million nest egg that has shrunk to $700,000. If you use half of your money to buy an immediate annuity, you would receive nearly $29,000 a year in payouts. (A woman would get slightly less because of her longer life expectancy.)
With the remaining $350,000, you could continue to invest in a diversified portfolio of stocks, bonds and cash, and withdraw 4% a year. That would produce another $14,000 annually. Together with the annuity payouts, your retirement income would total about $43,000 a year — $3,000 more than under the original 4% withdrawal scenario, even though your portfolio is now worth 30% less.
There’s a catch
Naturally, there is a downside: With an immediate annuity, you give up control of the money. And although you get the maximum monthly income with a single-life annuity, it stops paying out when you die. If you die prematurely, you forfeit a chunk of your initial investment (which is then returned to the investment pool to pay the benefits of other annuity holders).
Most couples choose a joint annuity that continues to pay out as long as either of them is alive. Although the annual payout is smaller than the payout from a single-life annuity, it ensures continued income for the surviving spouse. And if you’re concerned that you may both die before you have recovered your investment, you can choose an annuity that promises to refund any unused premium or to continue to pay out to your heirs for a certain number of years. However, each contingency benefit reduces the amount of your monthly check (see the box below).
HOW MUCH YOU CAN EXPECT FROM A $350,000 ANNUITY
Below is an estimate of how much monthly income you would receive for the rest of your life, depending on your age and gender, based on a $350,000 investment in an immediate fixed-rate annuity. Additional options include continuing payments to a beneficiary for up to 20 years if you die before then; refunding any unused premium to your beneficiary if you die before receiving the full amount of your investment; or paying 100% of your benefit to a surviving spouse (the example below assumes you and your spouse are the same age).
AGE (MALE) LIFE ONLY 20-YEAR PAYOUT REFUND OF PREMIUM 100% TO SURVIVOR
65 $2,394 $2,088 $2,264 $1,964
70 $2,714 $2,151 $2,494 $2,201
75 $3,183 $2,191 $2,797 $2,487
AGE (FEMALE) LIFE ONLY 20-YEAR PAYOUT REFUND OF PREMIUM 100% TO SURVIVOR
65 $2,241 $2,041 $2,151 $1,964
70 $2,497 $2,138 $2,397 $2,201
75 $2,883 $2,181 $2,624 $2,487
Source: AnnuityShopper.com
Motley Fool on Guaranteed Income for Life
My parents and I have been exploring some estate-planning options recently. They heard some presentations on equity-indexed annuities, and we decided to avoid those. (Read about why that’s smart.) We also learned about a much less troublesome option — the lifetime income annuity.
That’s not necessarily for everyone, but it does warrant your consideration. A recent Wharton School/New York Life study concluded that “lifetime income annuities are the most cost-effective and secure asset class for generating guaranteed retirement income for life.”
Here’s the good side of income annuities: In exchange for a sizable chunk of your money, they’ll provide you with an income — for life. This is attractive because we don’t know how long we’ll live. You might have a solid portfolio upon retiring at age 65, but what if you end up living to age 105? Will it be able to support you for 40 years, instead of the 20 or so years you might more reasonably be expected to live?
Also, if you’re investing mainly in stocks, you simply don’t know how well they’ll do in the future. Your future nest egg is far from certain. With income annuities, your income might well be lower than what you’d be able to withdraw from your stock/bond portfolio, but at least it will be guaranteed to last your whole life. You just can’t count on stocks to perform when you want them to. Coca-Cola (NYSE: KO) stock has recently been trading at levels it saw a decade ago, while Wal-Mart (NYSE: WMT) shares are roughly where they were eight years ago.
Drawbacks
Of course, there are downsides. When you spend money on an income annuity, you’re losing control of that big chunk of moola. If you’re a 60-year-old man in Maine, for example, one calculator I checked estimated that a $100,000 purchase would buy you roughly $7,000 per year. With $500,000, you’d get around $35,000. That might not seem like enough, but remember that it will likely be in addition to some Social Security payments and perhaps a pension or IRA withdrawals, too.
Another downside is that it eats up your estate. If you spend half of your nest egg on such an annuity, you’ll be leaving a lot less to your heirs, although some plans offer guaranteed payout periods with payments flowing to beneficiaries if you die before the end of the promised term.
Some long-grumbled-about issues with income annuities have been addressed in recent years, so the drawbacks have actually decreased in number. For example, you can now buy annuities indexed for inflation. This can be critical, especially if you’re buying while still relatively young, though of course it costs more. Some plans now permit you to tap your money in the event of emergencies, or to raise or lower your payments in the future.
What to do
So, should you rush out and put all your eggs in this basket? Of course not. But it might make sense, after some further research, to put a portion of your nest egg in one — or more. In ourRule Your Retirement newsletter, I read John Greaney’s take on them. (Rule Your Retirement is the retirement guidance resource I refer to most often. I encourage you tocheck it out for free.)
Greaney is no stranger to retirement issues — he writes about them frequently and actually retired himself, at the age of 38! When addressing these annuities (which should not be confused with variable annuities, which are harder to say nice things about), he notes that, according to his calculations, a portfolio of 60% stock and 40% cash (or short-term bonds) will usually serve you better. But notice the word “usually.” In some ways, this to-buy-or-not-to-buy decision comes down to your risk tolerance. If you want to play the odds, you might skip it. But for some peace of mind, you might consider it.
It can also make more sense if you’re somewhat older, such as in your 60s or 70s. At that point, you’re giving up less future stock market growth for your portfolio than if you diverted a big chunk of your nest egg into an annuity at age 50.
Greaney offered some good conclusions. For example, he suggests that with interest ratesso low these days, it could make sense to hold out for higher rates in the future, when your dollars will buy you more future income. It’s also important to buy from a company with high ratings — you don’t want your insurer (for this is an insurance product) to go belly up before you do. Greaney suggests possibly dividing your purchase among several insurers.
My parents and I have been exploring some estate-planning options recently. They heard some presentations on equity-indexed annuities, and we decided to avoid those. (Read about why that’s smart.) We also learned about a much less troublesome option — the lifetime income annuity.
That’s not necessarily for everyone, but it does warrant your consideration. A recent Wharton School/New York Life study concluded that “lifetime income annuities are the most cost-effective and secure asset class for generating guaranteed retirement income for life.”
Here’s the good side of income annuities: In exchange for a sizable chunk of your money, they’ll provide you with an income — for life. This is attractive because we don’t know how long we’ll live. You might have a solid portfolio upon retiring at age 65, but what if you end up living to age 105? Will it be able to support you for 40 years, instead of the 20 or so years you might more reasonably be expected to live?
Also, if you’re investing mainly in stocks, you simply don’t know how well they’ll do in the future. Your future nest egg is far from certain. With income annuities, your income might well be lower than what you’d be able to withdraw from your stock/bond portfolio, but at least it will be guaranteed to last your whole life. You just can’t count on stocks to perform when you want them to. Coca-Cola (NYSE: KO) stock has recently been trading at levels it saw a decade ago, while Wal-Mart (NYSE: WMT) shares are roughly where they were eight years ago.
Drawbacks
Of course, there are downsides. When you spend money on an income annuity, you’re losing control of that big chunk of moola. If you’re a 60-year-old man in Maine, for example, one calculator I checked estimated that a $100,000 purchase would buy you roughly $7,000 per year. With $500,000, you’d get around $35,000. That might not seem like enough, but remember that it will likely be in addition to some Social Security payments and perhaps a pension or IRA withdrawals, too.
Another downside is that it eats up your estate. If you spend half of your nest egg on such an annuity, you’ll be leaving a lot less to your heirs, although some plans offer guaranteed payout periods with payments flowing to beneficiaries if you die before the end of the promised term.
Some long-grumbled-about issues with income annuities have been addressed in recent years, so the drawbacks have actually decreased in number. For example, you can now buy annuities indexed for inflation. This can be critical, especially if you’re buying while still relatively young, though of course it costs more. Some plans now permit you to tap your money in the event of emergencies, or to raise or lower your payments in the future.
What to do
So, should you rush out and put all your eggs in this basket? Of course not. But it might make sense, after some further research, to put a portion of your nest egg in one — or more. In ourRule Your Retirement newsletter, I read John Greaney’s take on them. (Rule Your Retirement is the retirement guidance resource I refer to most often. I encourage you tocheck it out for free.)
Greaney is no stranger to retirement issues — he writes about them frequently and actually retired himself, at the age of 38! When addressing these annuities (which should not be confused with variable annuities, which are harder to say nice things about), he notes that, according to his calculations, a portfolio of 60% stock and 40% cash (or short-term bonds) will usually serve you better. But notice the word “usually.” In some ways, this to-buy-or-not-to-buy decision comes down to your risk tolerance. If you want to play the odds, you might skip it. But for some peace of mind, you might consider it.
It can also make more sense if you’re somewhat older, such as in your 60s or 70s. At that point, you’re giving up less future stock market growth for your portfolio than if you diverted a big chunk of your nest egg into an annuity at age 50.
Greaney offered some good conclusions. For example, he suggests that with interest ratesso low these days, it could make sense to hold out for higher rates in the future, when your dollars will buy you more future income. It’s also important to buy from a company with high ratings — you don’t want your insurer (for this is an insurance product) to go belly up before you do. Greaney suggests possibly dividing your purchase among several insurers.
Article Base
DO I HAVE ENOUGH?
What is the most popular question my new clients ask me in these difficult times, you ask? That is a simple one. I am often asked; “Do you think my retirement savings will last through my lifetime?” Sadly so, I often answer with bad news; “Only if you’re headin’ to the great blue yonder sooner than you think.” In other words: “If you die early.”
Running out of money is no fun. It happens all the time. My office is located next to a low-income apartment complex called “Trinity Towers”. In this complex, there must be a few hundred low-income seniors that are barely making ends meet. They often visit my office and hope somewhere in my desk is a magic rabbit. Sometimes it can be a real downer when I cannot help in those situations.
WHAT TO DO
Outliving your income is avoidable, especially if you start early and don’t wait to address the issue until funds are almost dry. For centuries, income annuities were the standard to promise a lifetime income for retirement. In fact, it still exists today with Social Security, traditional pensions, and the standard over-the-counter immediate annuity. Unfortunately, Social Security is not enough and most do not have pensions. Seniors are now faced with creating lifetime income on their own. In the recent past, creating guaranteed income for life was a big decision. The retiree had to forfeit a large deposit in return for that monthly cash flow for life. These were called immediate annuities as mentioned above. With these, the retiree had no access to the principle, only the monthly income, so it was a big decision, and it appealed to few seniors. The thought of trading cash for income sounds great, but what if I change my mind, or die early?
A NEW BALLGAME
Now, the ballgame has changed – totally. One does not have to forfeit the principle to receive lifetime income that is guaranteed for life. In fact, if you start lifetime income, you can even stop the cash flow at certain intervals and restart it again when (or if) you need it again. These new income plans are still nestled inside the safety of a fixed annuity, so you have all of the protection that is possible in a fixed insurance product with a strong company.
SOME EXAMPLES
Here is an example of a plan I use for my clients today: If Beverly, age 70, deposits $100,000 into the Lifetime Income Plan, she will be able to start an income plan after one year of roughly $578.00 per month. That is a 6.93% cash flow for the rest of her life. If she waits 5 years to take the income, she will receive $808.00 monthly for the rest of her life. And if she has the time and funds to wait 10 years, she will receive $1,385.00 monthly for life. Not too shabby.
The numbers even work sweeter if the client is age 50. If at age fifty, Eleanor places $100,000 into the Lifetime Income Plan and waits 20 years, the monthly income is $2563.00 per month. These numbers are simplified. If you have half this much to invest or five times the amount, just multiply my figures here by the respective magnitude. For example, if you are Eleanor’s age with $500,000, then your monthly check in 20 years will be $12,815.00 ($2563.00 times 5). Remember, even though the income is guaranteed for life, Eleanor does not have to continue with the plan if she chooses. She may stop the plan and walk away with the unpaid balance plus all of the earned interest!
BE DILIGENT
Additionally, if she were to die while Lifetime Income was being paid, her beneficiary would receive the unpaid balance. So it seems to be a win for you if you live, and a win for your family if you die early. The money is never forfeited and the client, or the family, will receive the funds eventually, all with built-in guarantees that really do work! Always be sure to weigh all your options, seek good advice and you‘ll most likely make the right decision.
The future is uncertain, especially with record government spending, deficits, the falling dollar, and a mounting national debt. This may be the best time to lock in some guarantees for your future security. Maybe you can ladder out a few Lifetime Income Plans that can be tapped at five-year intervals. If you have wondered what to do with idle cash, a failing mutual fund, or even if you just sold some property and need income – consider Guaranteed Income for Life. It may be the best deal around since income annuities are back!
Jason ValaVanis is a registered representative with and securities sold through LPL Financial, Member FINRA/SIPC.
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