Kiplinger Today


Guaranteed Income for Life

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).

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).
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
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

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