For most retirees these days, maximizing the amount of income they can safely take out of their portfolio is the most important financial objective. It’s the one thing that makes everything else possible. Being able to enjoy time with grandchildren, take time out to enjoy golf or travel, secure your nest egg against the need for long term care – it all hinges on your ability to convert your retirement nest egg to an income that will last you and your spouse a lifetime.
Some advisors rely on mutual funds and a tool called “Monte
Carlo” analysis – they use a computer to calculate hundreds of scenarios – all based
on backward-looking data, not forward projections – all to tell a soon-to-retire couple “based on what you’ve told me about your income needs and our best guess about your rate of return, I have good news! There’s only a 20 percent chance you will run out of money before you both die.”
That’s not good enough.
No one would want to get on an airplane with only an 80 percent chance of a safe landing. But financial advisors who rely on nonguaranteed investments such as mutual funds, stocks and corporate bonds do just that every day.
Surely there’s a better way to secure a guaranteed retirement income. Can regular people create their own pensions?
There is, and you can.
Lifetime Income Annuities
Lifetime Income Annuities, or LIA, exist to take a lump sum and convert it to a stream of income that you can never outlive – guaranteed. It’s simply a contract with an insurance company: You contribute premium, and the insurance company converts it into a contract guaranteeing, in writing, a certain amount of income each month or each year, for as long as you, or you and one other individual (usually a spouse) shall live. Guaranteed.
Advantages of Lifetime Income Annuities
The security of a lifetime income annuity may give you the confidence to seek greater returns with other parts of your portfolio, knowing that no matter what, your basic monthly expenses are covered.
Lifetime income annuities also generally allow for a substantially greater steady monthly income than you can get from a bond or mutual fund portfolio alone, unless you spend down principal. This is because of a concept called mortality credits. Essentially, those who die sooner than average don’t need their income anymore, so it goes to those who love longer than average. As a result, the lifetime income annuity is able to deliver a higher payout, on a guaranteed basis, than ordinary fixed annuities, CDs, money markets and income funds. In most cases, this payout is higher than that available from investment grade bonds, though individual bonds can vary widely in terms of coupon payments and risk properties.
Tax Deferral. Growth within annuities is tax-deferred. You only pay taxes on income you take out, attributable to growth. The portion attributable to the return of your own premiums is tax free. As a result, only part of your income from a lifetime income annuity is subject to income tax.
Lifetime income annuities also help get money out of your estate, potentially reducing estate tax liability.
In some jurisdictions, lifetime income annuities help provide asset protection benefits as well: Creditors may go after the income in a civil suit. They cannot generally touch your principal in a lifetime income annuity. You own a stream of income, rather than a lump sum. This makes it difficult for creditors to collect.
Disadvantages of Lifetime Income Annuities
Generally, a commitment to a lifetime income annuity is irrevocable. You should consider keeping enough cash or other reasonably liquid asset in reserve to react to a personal emergency. Some annuity contracts provide for one or two “accelerations” of several months’ worth of income. But individual contracts vary widely on this feature.
When interest rates are low, annuitizing your assets essentially locks in a lower payout than you could possibly get by waiting until rates rise.
Any assets you contribute to a lifetime income annuity for yourself and/or your spouse are lost to future generations. If you die early, the insurance company keeps everything. However, most annuities provide a death benefit – your heirs will receive the full amount you paid in, minus any benefits paid to you.
All benefits in an annuity contract are subject to the claims-paying ability of the insurance company. If the insurance company becomes insolvent, your benefits could be interrupted or reduced.
If you are retired or in the stage of planning your retirement, the lifetime income annuity is one of the most important tools in your kit. Give careful thought to how much of your retirement income you want to guarantee. And give us a call.