Finding Income in Retirement
An immediate annuity offers a guarantee for those fearful of the stock market
You can protect yourself somewhat by buying an annuity contract that guarantees payments for a set number of years. If you bought a 10-year annuity at age 65 but died at 70, your estate would collect the remaining five years of annual payments. Another criticism of fixed annuities is that over time the purchasing power of the income they produce diminishes. But today, some annuities also include inflation protection, increasing their annual payments by 2 or 3 percent a year or by adjusting their payments based on the consumer price index.
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Annuities may even be a better investment than stocks at times, depending on market conditions. Baylor University investments Prof. William Reichenstein studied various portfolios between 1972 and 2000. He found that a 65-year-old retiree with a $1 million portfolio invested in a mix of 40 percent stocks and 60 percent bonds withdrawing $45,000 a year from his account would have run out of money in 1995, at age 88, in part because of poor performance in the early years. Had he taken half of his portfolio and bought a fixed annuity instead, he would still have had $136,000 left at age 95.
"The neat thing about fixed immediate annuities is that they function like bonds in your portfolio," says Reichenstein. But the added advantage of the lifetime versions is that they promise to pay you the same amount until you die, not simply over five or 10 years. Moreover, while bonds can lose value, there is no such risk with these types of annuities. Because annuities are like bonds, investors don't have to have as much of their portfolios in fixed-income investments.
Margin of safety. Because insurance companies pool the money and life expectancies of thousands of annuity buyers, they can typically offer more income than an investor could safely generate with the same amount of investment. A 65-year-old man might only feel comfortable taking out $5,000 at most from a $100,000 retirement account. But that same man could go to an insurer and get a fixed annuity paying around $7,500 a year for the rest of his life.
"If you think you need a million dollars to retire but saved only $750,000, you can annuitize a portion of your account to spend as much as someone with $1 million," says Rande Spiegelman, vice president of financial planning for the Schwab Center for Investment Research.
But this does not mean an immediate annuity is for everyone. Some might already have enough guaranteed income from a traditional pension plan at work, for example. And you should not use all or even most of your assets to purchase an annuity. You never know when an emergency might arise or when your cash-flow needs will change. Most annuities lock in your money once you start receiving income.
The first thing to do is tally up your basic expenses, such as rent or mortgage, food, utilities, and healthcare bills. Then, add up the income you expect from Social Security and traditional pensions. If Social Security and your pension don't cover all your basic needs, consider filling in the gap with an immediate annuity, says Ted Mathas, executive vice president of New York Life.
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