A guaranteed lifetime income is a compelling proposition. After all—who doesn’t love the idea of being set for life? Financial planning for retirement begs for guarantees. While it is impossible to know how long you’ll live, it IS possible to make sure you will receive (at least) a certain amount of income for the rest of your life. Especially in this age of rock-bottom interest rates, a lifetime income annuity can be a lifesaver for some retirees!
Single Premium Immediate Annuities (SPIAs) can provide this income, yet few people use them in their retirement strategies. How can you know if a lifetime income annuity makes sense for your situation? Let’s explore.
Taking Longevity Risk Out of the Equation
When it comes to money, there are many types of risk. A couple of years ago, we profiled 16 ways to lose your money—and the list was by no means exhaustive.
A major risk involves timing. You might choose when you would like to retire… but how long will you live? It’s impossible to “plan” for an unpredictable time frame. It’s even harder when investments return unpredictable returns.
Mortality risk is the risk of dying too young. It’s a risk that insurance companies take, and one that families must also consider. The loss of a parent, spouse, partner, or child can be devastating—especially when others depend on that person’s income or contributions.
Longevity risk is the risk of living too long—and potentially outliving your investments. Longevity risk makes you afraid to spend your own money. It represents the guessing game around how much you can afford to spend now versus how much you might need later.
A long life is an amazing blessing, but it comes with financial risk. A sudden crash in the stock market could shatter your retirement nest egg. A drop in interest rates could compromise the cash flow you thought you could count on. For some, living to age 90, 100 or beyond can mean a lot less spendable income later in life—especially when inflation is considered.
By all means—build your retirement strategy around a long life! After all, it is your life; you should plan to enjoy it for as long as you are able. But how do you begin to take that longevity risk out of the retirement equation? Since you can’t plan the exact time-span of your retirement, you need to look toward products that guarantee a lifetime income.
Life insurance companies are the only companies that offer this kind of deal. Because these companies are on both sides of the risk—providing payouts to those who pass on, and income to those who live longer—they have a built-in protection on either side. On one side, the risk is that someone passes on too soon. The other side of the risk is that someone lives too long. This keeps the companies well-balanced, and allows them to assume all of this risk in the first place.
Now, don’t miss the significance of this for you and your family. Life insurance companies can protect you against longevity risk as well as mortality risk.
Everyone is familiar with the basic premise of life insurance. Aside from the many potential living benefits, when someone with life insurance dies, a death benefit is paid. The death benefit addresses mortality risk.
An annuity, on the other hand, pays you for LIVING—regardless of how long you live. Annuities are the ultimate protection against longevity risk. (And as an added bonus—there’s no physical exam required to qualify, as annuities are age-based.)
So… What is a Lifetime Income Annuity?
Let’s clarify some terms. A lifetime income annuity is one that pays an income stream for as long as you live. You purchase an annuity for a sum—then it pays you income.
An immediate annuity is defined as an annuity in which the first periodic income payment is due one income payment interval after the date that the annuity was purchased. In layman’s terms, it begins paying out income immediately after you put the money in the product. You can receive payments monthly or annually.
And a single premium annuity? That just means that for one lump sum of premium (payment), you receive a lifetime income. No further premiums (contributions) are expected or due.
The big benefit of a lifetime income annuity? You’ll have an income stream for life—no matter how long you live. You know exactly how much you can count on receiving, month after month!
And there is another significant benefit. When you trade your premium for an income stream and you are 70 or 80 years old, the insurance company can afford to safely pay MORE than typical “interest only” product. Therefore, annuities pay substantially MORE than bank CDs or treasury bills—without volatility or risk.
Breaking the 4% Rule
How much of your assets can you spend without running out of money? The general rule of thumb (though not without debate) has been the “4% rule.” Spend 4 percent of your assets each year, and in spite of market ups and downs, you’re not likely to run out of money.
But it’s hard for most people to live on only 4 percent of their assets. That’s only $40,000 of income for each million invested! And if you draw the money down faster—it may run out. Draw it down too fast, and the principal starts shrinking, along with your earnings.
What if you could count on 7 percent, 8 percent—perhaps even 9 percent or more—and know that the income stream would continue no matter what happened with the stock market or the economy? That’s exactly what an annuity does for you. When comparing potential annuities for a woman in her late seventies recently, we were able to obtain a benefit of 8.7 percent annually—guaranteed. That means that for every $100,000 premium, she could count on receiving nearly $8,700 annually. Rates of typically even higher for men due to differing longevity expectations. (Partners for Prosperity can help you compare annuity rates.)
In his influential 1965 research paper, “Uncertain Lifetime, Life Insurance and the Theory of the Consumer,” Dr. Menahem Yaari popularized the concept of using annuities to solve the problem of longevity risk. Still studied and quoted by economists today, Yaari established that if one’s primary motive was to maximize cash flow, annuities should be the primary, even exclusive component of a consumer’s portfolio.
Today, Yaari’s math and analysis still stands. His paper remains one of the most cited works in the study and research of economics. Immediate annuities can and do solve the longevity risk equation.
Then… Why Don’t More People Purchase Lifetime Income Annuities?
A TIAA-CREF study found that eighty-four percent of respondents said that receiving a guaranteed monthly paycheck during retirement is important to them; but only fourteen percent have purchased an annuity. Why is that?
First off, by the time people are of an appropriate age to purchase an annuity, they’ve usually decided on another path. Often, their broker or planner has guided them in a different direction.
Annuities have a bad rap—and that’s because some annuities are problematic. Some annuities are very complicated, and perhaps you have heard warnings about high fees and low interest returns. These are accurate critiques, but they refer to deferred annuities, rather than single premium immediate annuities. (We don’t recommend deferred annuities as a general rule, partly for these reasons. Plus, deferred annuities lock up your money for decades!) So the issue here is that people hear “annuities are bad” and they assume all annuities are the same.
Annuities can also be sold inappropriately. We don’t talk about annuities much simply because most of our clients are too young to purchase immediate annuities. If you are 50 or 60 years old, an annuity will not pay much income and it will not be nearly as effective. However, we are educating you now so that you are aware of this valuable option!
An annuity is a permanent decision, and that can feel scary. Once you annuitize, you can’t change your mind, remove your money and put it elsewhere. (This is another reason why we recommend annuitizing later in life… you maintain greater flexibility for longer.)
Perhaps paying a large premium, not knowing how long you will live, feels like a risk. What if you pass away next year and the insurance company gets to “keep” the premium? It IS possible for your beneficiaries to “inherit” that income for a pre-determined length of time, say, for a total of 10 years. There are also many other possibilities that involve beneficiaries—in return for a lower payout. The important thing to consider is the need for cash flow now. For many, it makes sense to maximize the cash flow of the lifetime income annuity and leave other assets (if possible) to beneficiaries.
While the permanency and the premium can scare people away, what should draw them back is a guaranteed income not dependent on market returns or conditions. With an annuity, there’s no need to draw from an account that has already experienced a loss. No need to take a reduction in income just to have enough for the next year. No stress about the future of your funds. No worries about market volatility or interest rates.
Clearly, an annuity can be an extremely valuable cornerstone of a retirement portfolio. Whether purchased with retirement plan money or with some of the cash value of a life insurance policy, consider how you can integrate the benefits of a lifetime income annuity.
Mix It Up to Add it Up
Your retirement income strategy should not be limited to one component. By adding a whole life insurance policy to your overall strategy, ideally in the earlier years of your working life, the policy’s cash value gives you leverage for a SPIA in later years. It can revolutionize the way you look at retirement.
Instead of HOPING to have funds to pass on to your heirs, why not CHOOSE exactly how much you want to leave? Identify a death benefit (or portion of a policy) to leave to heirs and annuitize (via a SPIA) the rest of the policy for yourself (and a spouse if applicable).
Purchasing a life insurance policy gives you the flexibility to get both. You can save and build your cash value well beyond what you put into the premium, and you get a death benefit that passes to your heirs free of income and (in most cases) estate tax. The policy then gives you the freedom and the leverage to buy yourself a guaranteed lifetime income. By tying these two assets together, you can create a lasting income stream without worrying about depleting your accounts, disinheriting your heirs, or how to put food on the table in years to come.
Modern Retirement “Planning” Fails Those Who Live Long Lives
Annuitizing your wealth in retirement has been put to the test again and again—the overwhelming result is that annuities are often EXACTLY the route you should take. And yet, so many people are employing problematic strategies that won’t deliver as much.
The glorified mix of stocks, bonds, and real estate can only take you so far in retirement. The assets on their own don’t necessarily stand up over time due to the unpredictability of the market. If you live too long, the money depletes because of the natural course of withdrawals, especially during losses. If you’re caught withdrawing during an extended “bear” market, you funds will run out quickly.
Putting money into a single premium immediate annuity that pays out over an extended amount of time, on the other hand, is not dependent on those same things. It’s an asset in which the life insurance company—not you—bears the risk. Some of you may pass on sooner, and some of you may live for years to come. The premium paid allows the company to pay out an income stream no matter what.
A Lifetime Income Annuity Isn’t for Everyone
You may still be wondering—is a lifetime income annuity for me?
If your primary goal is leaving the maximum legacy for heirs and beneficiaries, annuities aren’t the right vehicle. If you already have a healthy income stream, say, from a string of rental homes with double digit returns, an annuity won’t be that attractive. They aren’t for everyone. But for the average American wanting to stretch their retirement income, immediate annuities provide excellent cash flow with maximum certainty!
The litmus test, truly, is in your age. For those under 70, it may be too soon to consider a SPIA. You’d have to pay an extraordinary premium to create the income you desire over what could be several decades.
For those of age 70-75, or above, it’s likely the PERFECT time to think about annuitizing your wealth. It’s all to do with age—and this range is right in the sweet spot. You’re in a place where you’ve got wealth, and you likely have some years ahead of you, but you have not yet crossed the line into scarcity mode.
If you’re still on the fence, consider this: lifetime income annuities offer what mutual funds and managed money cannot: a guaranteed lifetime income. Like the other products a life insurance company provides, these SPIAs are INSURANCE. It’s insurance on your income—a guarantee that you will never be without an income. For more strategies, read our Ultimate Guide to Financial Planning Myths.
A stress-free, guaranteed income is priceless. And since lowering stress can lead to longevity—an annuity just might be the ticket to a long, happy life!
To find out more, contact Partners for Prosperity today. We can help you employ high cash value life insurance as an alternative for cash or if you (or your parents?) are over age 70, we’d be happy to provide lifetime income annuity quotes!
—Kim D. H. Butler with Kate Phillips and Elizabeth Hagenlocher