The greatest fear of most retirees is the risk of longevity: outliving their money. The meltdown of retirement accounts, rising medical costs, uncertain entitlement programs and higher taxes have added to the risk. Facing 30 years of retirement living on past savings and Social Security benefits is a scary reality. What can be done?
To handle other unaffordable risks you buy insurance. The same companies that protect your home, life, health and auto can also protect you from the risk of longevity. The basic principle of all insurance that makes coverage affordable is “pooling of risks”. Since the greatest fear of retirement is outliving your money and your remaining life span is uncertain, the solution is to insure the unaffordable risk. Let’s see how this is done.
Insurance companies issue fixed annuities, which can be turned into guaranteed lifetime incomes. You can accumulate your retirement money in an annuity over time, or you can fund the annuity lump-sum. Fixed annuities are backed by the assets of the insurance company, guaranteed to give you a positive rate of return which is free of income taxes until the earnings are withdrawn, and offer you numerous other choices. At the date you select, you can turn your annuity into a lifetime of monthly checks you cannot outlive. The insurance company guarantees you a lifetime of income, regardless of how long you live. You can later change your mind, stop the income and take your money lump-sum. If you die prematurely, your heirs are paid the balance of your account.
Let’s look at a hypothetical example that most insurance companies offer. Let’s say you are age 57, have $350,000 in an IRA account and plan to retire at 65. Parenthetically, you can put money in an annuity at any age and can start immediately to take an income. You’ll get the following by moving your IRA money to an annuity: (1) a 10% premium bonus that boosts your income account to $385,000; (2) a guaranteed growth in your income account of at least 8% annually; (3) the right to start a monthly income at any time after 591/2; (4) an annual lifetime income equal to 5.5% times your income account value at age 65; (5) the right to withdraw your money lump-sum if you change your mind; (6) no taxes on the annuity earnings until you start withdrawals; (7) no fees or commissions except 0.40% annual premium taken from earnings for the lifetime income guarantee. At age 65 and retirement what can you expect?
At age 65 the income account will be at least $712,608 since you were guaranteed at least 8% annual growth on your initial annuity premium plus the 10% bonus. Your annual guaranteed lifetime income will be $39,193 (5.5% of your $712,608 income account balance). If you should die prematurely, your account balance, if any, will go to your beneficiaries. If you change your mind, have an emergency, find a better value or whatever you can take your remaining money lump-sum. There are no medical requirements or other hassles. You are now insured against the risk of longevity and cannot outlive your money.
Insurance companies charge for their services and make a profit; thus, retirees that die too soon will subsidize those that live too long. The same as those whose homes were not damaged subsidizes those whose homes were damaged. Your retirement objective of a guaranteed lifetime of income was insured at a reasonable cost by pooling your longevity risk with that of other retirees. Combine your guaranteed lifetime income with Social Security benefits, and you have a comfortable and safe retirement with very little planning. Ask your financial advisor today about a fixed annuity with a Guaranteed Lifetime Income Benefit Rider.
Shelby J. Smith, Ph.D.