Retirement income can be a very stressful topic. How do you know if you will have enough money for retirement and how do you ensure that you do not run out of money? A review of your retirement assets should include a look at the options that exist for setting up a guaranteed retirement income for life. You have a few choices.
Pension
Traditionally, defined benefit pensions were the most common form of retirement funds. You and your employer each made contributions to the fund each year of employment. When you retired, you received a guaranteed income for life. Public employees still enjoy traditional pension plans, but very few private sector companies offer them anymore. Private employers have switched to defined contribution programs such as 401k plans.
Social Security
Almost all retirees receive Social Security benefits. You and your employers have paid into Social Security for your entire career. Recipients get a monthly guaranteed retirement income until they pass away. There are annual cost of living increases to keep pace with inflation. It is a wonderful concept with one serious flaw. The average monthly payment is only $1,350. Hardly enough money to live on even in areas with the lowest cost of living.
Create Your Own Guaranteed Retirement Income
Creating your guaranteed lifetime income is easy if you have assets in an IRA or 401(k). You simply set up a plan that pays you a steady amount. The trick is deciding on the proper amount. If the payment is too small an amount, you never enjoy the benefits of the principal. If the payment is too high, you can eat up the principal and run out of money before you run out of life.
A 2% annual withdraw of principal is easy to maintain at current yields on long-term Treasury securities and the dividend yield of the S&P 500 index. Anything over 3% relies on a rising stock market to maintain payments. Volatility in the markets could reduce your principal and require a reduction in the size of your distribution.
Retirement Income from Annuities
Single Premium Immediate Annuity
A Single Premium Immediate Annuity (SPIA) is a type insurance investment contract guaranteed income annuity. You pay a one-time lump sum to an insurance company. The insurance company looks at actuarial tables, interest rates, its expenses, and the fees it needs to charge to determine an amount of money it will pay you every month for the rest of your life.
Once you give the money to the insurance company it no longer belongs to you. If you were to die in six months, the insurance company keeps the balance of the principal. If you live 20 years longer than the actuaries predict, you receive a phenomenal return on your investment. Either way, you have the peace of mind that comes from having a stable guaranteed retirement income.
An Immediate Annuity is great for an individual who has no heirs and wants to receive the highest possible cash flow from their guaranteed annuity income fund. However, what if you have someone such as a spouse whom you would like to see taken care of for the rest of their life? There are variations on the SPIA designed just for such a situation.
Guaranteed Income Annuity Two-Life Plan
The two-life plan works the same as a standard SPIA except the payout is based on the life expectancy of both beneficiaries. If one person passes away, the remaining beneficiary receives the full benefit payment for the rest of their life.
You might be thinking that it is great to have a guaranteed income but what happens if inflation returns to a high level? Does your payment increase? The answer is no, but the issuers of annuities have investment choices available to alleviate this problem.
Variable Annuities
Standard annuities invest your principal at a predetermined interest rate. Variable annuities allow you to invest your principal in different portfolios consisting of stocks, bonds, and even real estate investments. These portfolios operate similar to mutual funds and sometimes are a special class of shares within mutual funds managed by the annuity issuer. You can receive monthly payments based on a set percentage of your portfolio and in the dollar value of your payments will increase as your portfolio grows.
The downside is that if the market goes down, your payment goes down. A decreasing payment is contrary to the concept of developing a guaranteed retirement income. However, knowing that this is a problem for some investors, insurance companies have developed variable annuities WITH guaranteed income options.
Guaranteed Income Variable Annuities
You can add a guaranteed income rider to your variable annuity. A rider is an additional contractual agreement that modifies the standard plan. Typically, a guaranteed income rider sets a lifetime payment that you receive no matter what happens in investment markets. The base value of your principal is set and never decreases. If the investment portfolios go up in value, your principal increases and you can elect to receive bigger payments. Many plans allow the transfer of all or part of your funds from a variable annuity into a standard annuity once per year.
There is a cost for the privilege of having your cake and eating it too. Some companies will charge you a small premium or fee based on the value of your portfolio. Others charge no additional fee but when the market goes up they receive a percentage of the increase in portfolio value as payment for the guaranteed income and principal stability option.
When to Set Up a Variable Annuity
You do not have to wait until retirement to set up a variable annuity. A variable annuity can be set up at any time with a lump sum payment, a stream of monthly payments, or a combination of both. Your profits accumulate and compound with taxes deferred until you begin receiving payments from your account. You can then wait until you retire to set up the guaranteed income option.
The money for your variable annuity contribution can come from many sources including the sale of a home, an employment buyout payment, or even from your 401(k) or IRA accounts. Many people choose to set up a variable annuity within a retirement savings plan. Any taxes on income payments and the profits on their reinvestment is delayed until you decide you to withdraw money. Roth 401(k) or Roth IRA accounts are very attractive vehicles for holding variable annuities as withdrawals from Roth accounts are not taxed if the account has been open for at least five years and you are more than 59 ½ years old. You not only have a guaranteed income fund but a tax-free guaranteed retirement income for life.
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