New Strategies to Lock In Steady Income for Life

One of the greatest challenges in retirement is figuring out how to convert a pile of savings accumulated over a lifetime into a monthly stream of income that you can't outlive. The issue is gaining new urgency as the oldest of the baby-boomers start turning 65 this year. They are ushering in a new era in which retirees must anticipate longer life spans, stock market volatility, low interest rates on savings and rising health care costs.

For many new and soon-to-be retirees, there are no precedents or guideposts for these financial decisions. It's not like your parents' retirement, when people simply signed up for Social Security benefits and, if they were lucky, collected a pension. Many boomers have worked for numerous companies during their careers and have retirement savings stashed in a variety of accounts. But most are unlikely to be covered by a pension or retiree health benefits. It's up to them to figure out how to stretch their savings over a retirement that could last 30 years or more.

To meet the growing need for predictable retirement income, insurance companies are developing new annuity products that are cheaper, less complicated and more flexible than earlier versions. (An annuity is a contract with an insurer that promises to pay you a set amount of income for the rest of your life or for a set period of time.) Mutual funds and brokerage firms -- which in the past preached the value of relying on the stock market for investing both before and during retirement -- are also climbing on the annuity bandwagon as part of a broader retirement-income strategy.

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"We believe you should support your essential expenses with guaranteed sources of income -- a pension, Social Security and/or an annuity," says Chris McDermott, senior vice-president of investor education for Fidelity Investments. "An annuity can be an efficient vehicle, but it has to be the right amount for the right person."

Bridging the gap. Chuck Fallini of Carlsbad, Cal., likes the idea of combining a long-term investment strategy with an income guarantee. He used a new tool from Fidelity to figure out how to invest the lump-sum benefit he received when he took early retirement from Verizon. Fallini, 58, wanted to continue investing primarily in stock funds for the long term. But mindful of the devastation that the 2007-09 stock market meltdown inflicted on many nest eggs, he also wanted some income guarantees.

After using Fidelity's Income Strategy Evaluator, Fallini decided to invest a small portion of his portfolio in the Fidelity/MetLife Growth and Guaranteed Income annuity, which has a monthly payout that can increase from year to year if the market performs well but never declines, even if the market does. He allocated another 25% of his assets to fixed-income investments, which along with his annuity payouts cover the bulk of his regular expenses. He invested the balance of his retirement assets more aggressively in a variety of low-cost mutual funds, exchange-traded funds and a few individual stocks. So far, he's satisfied with the three-prong retirement-income approach: "It provides upside potential with the protection of the guarantee," he says.

Fidelity's free tool is not just for Fidelity customers; anyone can use it. The Income Strategy Evaluator (www.fidelity.com/incomestrategy) conducts a detailed analysis of your retirement savings, expenses and income, then helps you decide how much of your portfolio to allocate to stocks, bonds and cash to provide for potential growth. It also shows the value of buying one or more annuities to create guaranteed income and provide protection from inflation and market volatility.

There are different types of annuities for different purposes. Immediate-payout annuities, which are low-cost and straightforward, provide a fixed monthly paycheck for life but can lose buying power over time. Immediate annuities that offer cost-of-living adjustments provide monthly income that keeps pace with inflation, but initial payouts are smaller than the fixed-interest variety. Deferred variable annuities are more complex, involving an investment component that allows your income payout to increase each year if the market performs well but protects your income from declining even when the market tanks.

Because many investors are wary of the costs and restrictions of annuities, the Fidelity tool also offers retirement-income strategies that do not include guaranteed-income products. The trade-off is that you need to invest a lot more money in a diversified portfolio than it would take to buy an annuity to generate the same amount of income.

For example, retirees are advised to restrict initial withdrawals from their savings to about 4% to avoid outliving their money and to give themselves an annual raise -- when possible -- to keep pace with inflation. In contrast, an immediate annuity can pay out 7% or more of your initial investment annually, depending on your age. In return for those high payouts, however, you relinquish access to the principal, which means you can't access the money later for emergencies or extra expenses. Because of those limitations, you should invest only a portion of your retirement savings in an immediate annuity and keep the rest invested for long-term growth -- with some set aside in a liquid account for emergencies.

Other strategies. MetLife recently unveiled its own Retirement Income Selector at www.metlife.com. It's similar to Fidelity's tool, except that it adds longevity insurance -- a relatively new concept that could be the next big trend in lifetime-income strategies.

Here's how longevity insurance works: You invest a certain amount when you retire and wait years or even decades for the annuity to pay out. Say you invest $50,000 at age 65 in MetLife's longevity annuity and wait until age 85 for the annuity to pay out. If you live that long, the payoff is huge: $35,205 per year for the rest of your life. But if you die before age 85, you get nothing.

So far, few consumers have been willing to gamble on longevity insurance, and only a handful of insurers, including MetLife and New York Life, offer it. But many academics and actuaries think it is a brilliant solution to one of the biggest unknowns in retirement planning: how long you will live. "It takes the pressure off what you're doing in the early years," says Noel Abkemeier, of Milliman, an actuarial consulting firm. Knowing you have guaranteed income that kicks in later in life makes it easier to invest the rest of your money without worrying about outliving your savings. "If you make some mistakes or the underlying investments tank early on, you know you'll get a fresh start at age 85."

Longevity insurance seems to be gaining traction among other financial services companies. Bond-fund giant Pimco recently announced a partnership with MetLife to create a new retirement-income product that combines investments and insurance. Investors can now purchase Pimco Real Income funds to provide regular, inflation-adjusted monthly distributions over a set period of time, and separately buy MetLife longevity insurance to provide monthly income after mutual fund distributions end.