How 2 Couples Covered Their Income Gaps for Life with Income Annuities

Two couples walk on a path side-by-side.

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When you’re planning your retirement, consider your need for cash flow. If your cash flow isn’t right, the rest of your investment strategy will become unstable. You may need to sell off investments when you have to rather than when you want to.

Your Retirement: What’s Luck Got to Do with It?

To determine your needs for cash now and in the future, here are some questions to ask yourself:

When do I plan to retire?
How much income will I need beyond Social Security and my pension, if any?
Will I start taking my Social Security benefits early, at full retirement age, or wait until 70?
How will I use my savings and investments, both taxable (nonqualified) and qualified plans, such as my IRA, 401(k) or Roth IRA, to create retirement income?
What’s my risk tolerance?
If I and/or my spouse live to a very advanced age, will our savings last?

The more you save, the better off you’ll be. My previous article discussed fixed deferred annuities as tax-advantaged vehicles to boost savings.

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This article covers a different type of annuity — the income annuity, which is what people think of as a classic annuity.

First, Some Basics on Income Annuities

If you’re willing and able to give up control over some of your assets now in exchange for immediate or future income, consider an income annuity. Most are bought with a single premium deposit.

There are several options. If you’re married, you can purchase a joint-payout version, where payments will continue as long as either spouse is living.

You can choose to receive payments over a set period, such as 20 years. Most people, however, choose lifetime payments, which serve as insurance against the risk of running out of money in old age. With an immediate income annuity, the income starts right away. With a deferred income annuity, also called a longevity annuity, payments will begin at a future date you choose.

One Example: John and Jane Buy an Immediate Income Annuity

John and Jane are going to retire next month when they each turn 65 and start receiving Social Security, which will cover all but $3,000 of their basic monthly expenses. They can create that much current income by depositing $728,572 in an immediate joint lifetime annuity (as of August 2021).

Moving to Another State in Retirement? What You Need to Know

Since they want to leave money to their two children, they choose the cash-refund feature. If they both pass away before their monthly income payments equal the amount of the annuity purchase price, their beneficiaries will receive the difference. This option slightly increases the premium deposit required to achieve their monthly income target.

Their $3,000 monthly payments will include $705 of taxable interest and $2,295 of nontaxable return of principal. If either or both live to age 91½, the entire principal will have been repaid by then. However, their income won’t be reduced, and that’s where the insurance aspect kicks in. At that point, the annuity income will be fully taxable but will continue for as long as either one of them is living.

They could have selected an inflation rider, but they would have had to make a larger deposit to get the same income, and so they decided against it. Furthermore, John and Jane won’t start taking out money from their IRAs and 401(k) plans until their required minimum distributions begin at age 72, and that will substantially boost their income then, offsetting the costs of inflation.

Based on conservative assumptions about the performance of a balanced portfolio plus future inflation-based increases in Social Security and the guaranteed annuity income, they feel comfortable they’ll never run out of money.

A Different Strategy: Bob and Sam Go for a Deferred Income Annuity

Bob and Sam, both age 60, are a married couple, and they each plan to retire at 65. They also figure they’ll need $3,000 a month in additional income when they retire in five years. They decide to buy a deferred income annuity that will provide lifetime income starting at 80. To give themselves a cushion for inflation, they choose a $4,200 monthly benefit. For the 15 years between 65 and 80, they’ll rely on Social Security, investment income and withdrawals from their retirement plans to fill the gap.

They also choose a joint-payout contract. But they decline the cash-refund option because they’re not concerned about leaving the money to heirs. They buy a deferred lifetime income annuity with a $314,102 deposit (as of August 2021). They decide to sell their bond funds to pay for the annuity, because an income annuity can substitute for bonds in their portfolio.

Each $4,200 monthly payment will include $2,167 of taxable interest and $2,033 of nontaxable return of principal.

The amount they deposit is lower, because the insurance company is investing their money for years before payments start, and the payments on average won’t last as long. Additionally, skipping the cash-refund option saves them money.

Since they know they’ve secured income for their old age, Bob and Sam feel freer to spend more money in the early years of retirement, when they plan to travel extensively.

The Bottom Line

There’s no one right answer to retirement income planning. However, annuitizing a portion of your savings and insuring for longevity is an optimal way to guarantee income for life and remove the worry about running out of money.

A free quote comparison service with interest rates from dozens of insurers is available at https://www.annuityadvantage.com or by calling (800) 239-0356.

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Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Retirement-income expert Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed and immediate-income annuities. Interest rates from dozens of insurers are constantly updated on its website. He launched the AnnuityAdvantage website in 1999 to help people looking for their best options in principal-protected annuities. More information is available from the Medford, Ore., based company at www.annuityadvantage.com or (800) 239-0356.