By Ken Nuss
If you’re afraid of running out of money in your golden years, join the crowd. Inflation is running rampant. Gas prices remain high. Property taxes, rent, medical care, food and other necessities keep going up. The long-term fate of Social Security is in doubt.
Instead of worrying, act now to secure your financial future so you won’t run out of money no matter how long you live, even if you pass the 100 mark.
Investing in qualified retirement plans, including traditional or Roth IRAs and a 401(k) or similar plan, is one cornerstone. Annuities are another foundation. Here’s how investing in annuities now can boost your financial wellbeing in the future.
Some annuities build savings through tax deferral
Deferred annuities build cash value and let your retirement nest egg grow faster through tax deferral. Fixed-rate annuities act much like bank certificates of deposit, but add tax deferral, and pay a set rate for a certain term. Fixed-indexed annuities offer a fluctuating interest rate, determined by a crediting formula applied to an investment-market index but also guarantee your principal. Investment-oriented variable annuities offer tax deferral, but not guaranteed principal, and sometimes have high fees.
When you are retired, you can receive income and if necessary principal from your annuities. Any interest income (but not principal) you receive will be fully taxable, but in retirement you may be in a lower tax bracket. Even if you’re not, you’ll still come out ahead because you have deferred paying income taxes for years.
Other annuities provide a personalized private pension
Income annuities, also issued by life insurance companies, are quite different. They have no cash value normally. Instead, you’re securing a guaranteed stream of income. You can buy an income annuity with a single cash premium deposit. If you already own a deferred annuity, you may convert it to an income annuity through a process called annuitization, or exchange it tax-free for an income annuity with a different company. You can even use IRA funds to purchase an income annuity.
With a lifetime income annuity, you can create your own custom pension. You can convert your savings into a monthly income that’s guaranteed for life. Economists agree that annuitizing a significant portion of your retirement savings is a smart strategy, according to a study from Wharton Financial Institutions Center.
A lifetime annuity insures against the risk of living longer than average. Today, a healthy 65-year-old man has a 50 percent chance of living beyond age 85 and a 25 percent chance of living beyond 92. A healthy 65-year-old woman has a 50 percent chance of living beyond 88 and a 25 percent chance of living past 94.
With lifetime annuities, the 50 percent of people who die earlier than average essentially subsidize the rest who live longer than average. Risk-pooling is what makes lifetime annuities so valuable.
You can self-insure against longevity risk by investing in stocks, bonds, and savings (including fixed annuities.) But you’d need to save 25 percent to 40 percent more than with an income annuity because you won’t have the advantage of risk-pooling, the Wharton study concluded.
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Try to determine how much monthly income you’ll need at a minimum in retirement. Then, subtract out Social Security and other pension benefits, if any. You can cover the remaining shortfall by purchasing a lifetime annuity.
If your need isn’t immediate, you can choose a deferred income annuity and start receiving income at a future date you choose. This lets your money compound longer.
What if I need income soon?
If you’ll need income soon, you can buy an immediate annuity, with income payments beginning within about a month if you like. Because a portion of the income is taxable, you may want to wait until you’re about to enter retirement or semi-retirement before receiving them.
Bonus: today’s higher interest rates let insurers pay more
While inflation is bad news, higher interest rates have a benefit. When rates are high, annuities pay more. Here’s an example:
- John Dough, age 65, can create a $1,610 monthly lifetime income by depositing $250,000 in an immediate annuity from a highly-rated insurance company. That’s a 7.7% gross payout rate, a withdrawal percentage you’d be hard-pressed to achieve with a traditional investment portfolio without the risk of running out of money. If he lives an average lifespan, to 85, he will collect $386,400 in benefits—not a bad return.
But longevity insurance really kicks in after 85. If Mr. Dough lives to 93, he will collect $540,960 in total. Now, suppose Mr. Dough doesn’t need income right now. He buys a deferred income annuity, with payments starting at age 75. He’ll get $3,604 a month for life starting then.
Do your homework before investing
Since you’re counting on an insurance company to keep its promise of providing lifetime income, be sure to choose a financially strong insurer. Annuities are not insured by the FDIC. State guaranty associations, however, provide an additional level of protection for annuity buyers, but if you choose a strong company, it’s extremely unlikely you’ll ever need to rely on the guaranty fund.
Also, be aware of tax implications. Interest income received from an annuity before age 59½ is normally subject to a 10 percent IRS penalty. However, you can avoid that penalty when purchasing a lifetime payout annuity.
Meanwhile, ax wasteful spending
Securing retirement income is probably the most crucial financial task of your life. If you’re not saving enough for your future, look at your current expenses and see where you can trim them.
Are there subscriptions you’re not using? Are you driving a jumbo SUV or pickup when a more fuel-efficient vehicle would be fine? Are you turning off electronics and vehicles when they’re not in use and not overly air-conditioning or overheating your home? Do you pay off your credit charges in full every month?
Small steps can add a bit to your savings every month, and those bits can add up to something big over time if you use them to boost your retirement savings.
About the author: Ken Nuss
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 https://www.annuityadvantage.com or by calling (800) 239-0356.