A number of strategies can help you stretch your retirement savings over your lifetime. But when it comes to choices you control, only an annuity guarantees that your income—or a portion of your income—will continue no matter how long you live.
See Also: Understanding Annuities Special Report
You can integrate an annuity into your retirement income strategy in a variety of ways (see Make Your Money Last). One popular method is to add up your regular expenses (such as housing, food, utilities, insurance premiums and out-of-pocket health care costs) and subtract any guaranteed sources of income (such as a pension and Social Security). Then buy an immediate annuity to provide enough income to fill in the gap. Once you know those costs are covered, you can invest the rest of your money more aggressively—providing extra funds to keep up with inflation, cover emergencies and other large outlays, or leave to your heirs.
The simplest way to provide lifetime income is with a single-premium immediate annuity: You hand over a lump sum to an insurance company when you retire, and it pays you a regular check for life (or for as long as you and a beneficiary live) starting right away. (With a deferred variable annuity with lifetime income benefits, another flavor of annuity usually sold to preretirees, you invest a chunk of money in mutual-fund-like accounts in exchange for a promise of a stream of income in the future.)
Immediate annuities may be simple, but they come with a couple of caveats: Because this type of annuity has fixed payouts that usually aren't adjusted for inflation, and because you can't reclaim the money once you commit it, you should invest only enough to help cover regular expenses and no more. More problematic are today's low interest rates; now is not a good time to lock in a fixed payout for the rest of your life.
"Because of historically low interest rates, an investor who purchases an immediate annuity now may be solving an emotional dilemma—fear of market risk or fear of loss of income—at the expense of their financial best interest," says Tim Maurer, a certified financial planner in Hunt Valley, Md. For example, if a 65-year-old man invests $100,000 in an immediate annuity now, he'll receive about $6,900 per year for life—about $1,800 a year less than if a 65-year-old had bought the annuity five years ago. Low rates translate into lower payouts because the insurer earns less on its money.
You can combat lower payouts a couple of ways: by laddering annuities or by buying a relatively new product that guarantees heftier payments if you pick a date down the road to begin receiving them.
The annuity ladder
One way to avoid locking in too much money at low rates is to buy an immediate annuity now with a portion of your savings and invest more in annuities every few years. Payouts will be higher because you'll be older; they'll also increase if interest rates rise.
Michael Ritschel of Colorado Springs retired four years ago as a financial consultant. He receives a small pension and Social Security, but most of his retirement income comes from his own savings. Ritschel, who is 73, has 20% of his portfolio in fixed-income investments and 60% in dividend-paying stocks. He plans to put the rest of his savings in immediate annuities to cover living expenses for himself and his wife. He recently bought his first annuity and plans to make two more purchases over the next six years. "My goal is to have enough income to cover the necessities and to provide growth with income that will keep up with inflation," he says.
The older you are when you buy an annuity, the higher the annual payouts—assuming interest rates don't fall further. For example, a 73-year-old man who invests $100,000 in an immediate annuity now could get $8,820 per year for life; a 75-year-old could get $9,432 per year for life; and a 77-year-old could get $10,200 per year for life. If interest rates rise by the time the man purchases the annuities, the payouts will be even higher.
You'll receive the highest payouts if you choose a life-only annuity, which stops paying when you die. (Ritschel chose that version because he already has a universal life insurance policy, with his wife as the beneficiary.) You'll receive a lower annual payout if you buy an annuity that pays out as long as you or your spouse lives. If you're worried that you might both die early, you can choose an option that guarantees payments (to you or your heirs) for at least ten years. A 70-year-old man who invests $100,000 in a single-life annuity could get $7,956 per year, or he could get $6,684 for payouts that continue as long as either he or his wife (also 70) lives. The income would be $6,588 per year if payouts continue as long as either spouse lives or for at least ten years.
Having the annuities to cover his retirement expenses allows Ritschel to feel comfortable investing his remaining savings more aggressively, because he won't need to sell his investments in a down market to pay his bills.
Defer the income?
Annuities can protect against outliving your income, but you don't really benefit from that protection early in retirement. For that reason, academics and actuaries have embraced products that delay payouts until much later—typically your seventies or eighties—when you're most concerned about outliving your savings. "If you focus your longevity-risk thinking on those later years, it's less expensive," says Tom Terry, president-elect of the American Academy of Actuaries.