Income and Life Expectancy Not Adding Up? An Annuity Could Solve the Equation
Increasing longevity means many of us run the risk of outliving money we've saved for retirement, and Social Security may not bridge the gap. Could an income annuity be the answer?
When you retire, you'll need income to replace the money you used to earn. If you have a fantastic pension and/or great wealth, no worries. But most retirees need new sources of income.
Social Security benefits alone rarely suffice and may be less generous in the future. Mandated IRA or 401(k) withdrawals are also part of the equation, and retirees who've put significant portions of their savings in stocks have done very well since 2009. But with the market near all-time highs, equities look riskier now.
What if you live well beyond the average lifespan? Will you run out of money? That risk rises for a married couple. For a 65-year-old heterosexual couple, the odds of at least one spouse reaching 90 are between 50% and 59%. There's a 7% to 8% chance both spouses will live to at least 90.
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Annuities can produce safe retirement income and can guarantee that income for life, making them unique vehicles for reducing the risk of running out of money in old age. Let's look at the features, pros and cons of two options: A fixed indexed annuity with a lifetime income rider and a traditional income annuity.
Fixed indexed annuity with add-on: An innovative way to guarantee lifetime income
A fixed indexed annuity is a type of deferred annuity that credits interest based on the changes to a market index, such as the Dow Jones Industrial Average or S&P 500. Interest is credited when the index value increases for the year, but when it falls, you lose nothing, and that reduces risk and volatility.
It's sort of a have-your-cake-and-eat-it-too product, but you get only part of the cake, normally. In exchange for the no-loss guarantee, you'll typically get only part of the market's gains, especially in years where it's way up.
When you buy a traditional lifetime income annuity, you no longer have access to your money. Since the insurance company has converted your savings into a guaranteed stream of income, there is typically no cash surrender value.
An indexed annuity plus a rider (an add-on), often called a guaranteed lifetime withdrawal benefit (GLWB), avoids that drawback. You can get a high level of future guaranteed lifetime income while still maintaining control over your unused account balance. And you also usually retain complete flexibility about when you start receiving income. You can even stop receiving income and still access any remaining balance in your policy.
How the lifetime income rider works
The GLWB rider creates a second policy value called the "income account value." This is a calculating factor that determines the amount of your guaranteed income payments. It's separate from the underlying contract value. It has no cash value and cannot be withdrawn, but it is a real benefit.
The income account value typically grows at a guaranteed annually compounded rate of 6% to 10%. Your monthly lifetime payments are determined by the payout percentage, your income account value, your gender and your age when you start taking payments. If you can wait longer, you'll get more guaranteed income.
Different insurers use different actuarial calculations. Therefore, you may get more or less from a particular insurer even when all other things are equal.
Adding an income rider to an indexed annuity can be a powerful combination, but there is a cost, for instance, about 1% per year to get a 10% guaranteed annual income account value growth. This fee will be subtracted from your account value. That percentage may sound small, but if you have the annuity for many years, it will add up.
If you live long enough, the payments you get will deplete your account balance. But despite that, those payments will continue uninterrupted. That's the valuable "longevity insurance" GLWBs provide.
Some insurers claim their product can deliver much more future lifetime income, perhaps up to 60%, than a traditional stock and bond portfolio would under a reasonable scenario. That may be true, but your annuity agent should show you an analysis to determine how realistic it is.
Income annuities, immediate or deferred, are still a good option
While indexed annuities with GLWBs can definitely help protect you from inflation and the financial risks of longevity, they are complex, and it takes some work to figure out which one offers the best deal for you. If you want a simpler approach, consider the time-tested traditional income annuity.
For guaranteed lifetime income starting very soon, an immediate annuity is likely your best option. You can have your first payment in just a month.
You usually buy the annuity with a lump sum. In return for that deposit, the insurer gives you a contract that specifies how much income you'll get for life. You've converted your savings into your own private pension.
You can get inflation protection with a cost-of-living adjustment (COLA) rider that increases future payments by a fixed percentage, for instance, 1% to 5% annually. However, you will receive a lower initial payout.
You can buy either a single-life annuity or, if you're married, a joint-life annuity, which will cover both spouses. If your husband or wife outlives you, he or she will continue to get the same payments for life.
There are tax advantages, too. Each payment includes both tax-free return of principal and taxable interest. Once your entire principal has been paid back, which usually takes many years, the payments will become fully taxable.
Think you or your spouse may live to 95? Consider 'longevity insurance'
A deferred income annuity, sometimes called a longevity annuity, defers payments until a future date that you choose. Most buyers choose to start taking payments when they turn 80 or older. The longer you defer payments, the larger they'll be.
You'll know the exact amount of monthly lifetime income you'll receive and the exact date when it begins. You can buy either a single-life annuity or a joint-life annuity, which typically covers both spouses. It's a very efficient way to protect against outliving your assets in very old age.
The insurer invests your money for many years, enabling it to compound until you begin receiving income. Second, buyers who do not live to an advanced old age subsidize those who do. The longer you delay taking payments, the greater the monthly payout.
The longevity annuity offers a different way to plan for retirement. Suppose you'll retire at 65. You can use part of your money to buy a longevity annuity that will provide substantial lifetime income starting at 85, for example.
Then, with the balance of your retirement money, you only need to create an income plan that gets you from 65 to 85. You don't have to deal with the uncertainty of trying to make your money last for your entire lifetime.
You can buy a longevity annuity with taxable savings or within an IRA. The latter is called a qualified longevity annuity contract. A QLAC is a type of longevity annuity designed to meet IRS requirements. It lets you delay required minimum distributions. There's currently a $210,000 per-individual lifetime limit on deposits.
Neither an income rider nor a longevity annuity is the best choice for everyone. Both have their places, and pros and cons. Choosing the best income solution for you takes analysis and careful consideration.
Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed, and lifetime income annuities. Ken is a nationally recognized annuity expert and widely published author. A free rate comparison service with interest rates from dozens of insurers is available at www.annuityadvantage.com or by calling (800) 239-0356. The firm also offers an income-annuity quoting service. There are no fees or charges for the firm's services; 100% of the client's money goes to work for them in their annuity.
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