How to Create Your Own Pension

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Sandra Block August 30, 2018

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With an immediate annuity, you could get a monthly paycheck for life.

Guarantee Income

Those who don't have a traditional pension -- and that includes most of us -- are frequently envious of those who do. What could be better than a guaranteed paycheck that lasts as long as you live and is unaffected by the vicissitudes of the stock market?

There's another way: Create your own pension with an immediate annuity. Unlike the complex (and usually high-cost) indexed annuities that are sold at free lunches and dinners, immediate annuities (sometimes known as single premium immediate annuities, or SPIAs) are straightforward: You give an insurance company a lump sum and, in return, receive a monthly check, usually for life.

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A lot of policymakers and retirement experts believe annuities could go a long way toward improving retirement security in the U.S. But with immediate annuities, security comes at a cost: Once you buy one, you usually can't get your money back. (Some insurance com­panies allow you to make a one-time cash withdrawal to cover a financial emergency, such as a large medical bill.) But investing some of your savings in an immediate annuity could help you sleep at night, particularly if you're worried about a market downturn. If your monthly payout covers your expenses, you'll have more flexibility to ride out a bear market because you won't have to tap your investment portfolio to pay the bills.

What to look for. If you're interested in buying an annuity, start by tabulating your cost of living. Break down your expenses into mandatory and discretionary categories, says Randy Bruns, a certified financial planner in Downers Grove, Ill. (If you like to live large, you may want to create a third category for luxury expenses.) Once you've completed that exercise, you can buy an annuity that, along with Social Security benefits, will cover your basic expenses, such as groceries, your mortgage, utilities and property taxes.

Next, go to to get an idea of how much you'll need to invest to generate that amount of income. For example, if you're a 65-year-old man and need $1,500 a month to keep the lights on and food in the fridge, you'll need to invest about $266,000 for a single-premium lifetime annuity. If your wife is also 65 and you want an annuity that will continue to pay as long as one spouse is alive, you'll need a joint-and-survivor annuity. To generate $1,500 a month, you’ll need to invest about $316,000.

While immediate annuities are less complex than some of their higher-fee cousins, there are optional features worth considering:

Inflation rider. One downside to immediate annuities is that inflation will erode your monthly payments over time. You can buy an annuity with an inflation rider, either one that increases at a set rate so that your income rises each year by a specific percentage (usually 3%) or one that increases (or decreases) each year based on changes in the consumer price index. The trade-off is that during the first few years, your monthly payouts will be up to 28% lower than those from an annuity without the rider. If you're using the annuity to cover expenses that won't change much (such as a fixed-rate mortgage), you may be better off skipping this feature in favor of larger payments.

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An alternative is to ladder annuities -- that is, spread out your annuity purchases over several years. If interest rates go up, the payments on annuities you purchase in the future will be higher. You'll be older, too, and that automatically means your payments will increase.

Survivor benefits. Many people eschew annuities because they hate the thought that they might die before they've spent the money they've invested, says Stan Haithcock, an independent annuity agent in Ponte Vedra Beach, Fla. But it doesn't have to work that way. You can buy an annuity that will pay your beneficiaries a lump sum based on your original investment, minus any income payments made to you. This feature will cost you more. A 65-year-old man who wants to generate $1,500 a month would need to pay about $291,000 for this feature -- $25,000 more than he would pay for an annuity that ends when he dies. If he buys a joint-and-survivor annuity with this feature, he'll need to invest about $323,000.

Deferral. Deferred-income annuities don't provide immediate income, but they protect you from the risk of outliving your money. Typically, you purchase them in your fifties or sixties, but payments don't start for at least 10 years. If you die before payments start, you get nothing (unless you opt for survivor or return-of-premium benefits). A 65-year-old man could buy a deferred annuity that pays $1,500 a month in 10 years for about $110,800.

Safety and soundness. When you buy an immediate or deferred annuity, make sure the insurance company has the financial strength to make good on its promise. Look for an insurance company that has a top rating from A.M. Best. Comdex is another source: It compiles a composite index of insurers based on ratings from all of the agencies (including A.M. Best, Moody's and others). You can download a free Comdex report at Haithcock's website, (click the "Resources" tab).

Tapping Life Insurance

If you've owned a permanent life insurance policy for many years, you may be able to buy an immediate annuity without tapping your retirement savings. You can convert your policy to an immediate annuity through what's known as a 1035 exchange. You'll give up the death benefit, but you'll lock in income for the rest of your life, or for a guaranteed number of years. The conversion is tax-free, but you'll pay taxes on a portion of each payout, based on the proportion of your basis (the amount you paid in premiums) to your gains. Your insurance company may offer a way to swap your insurance policy for an annuity, but check with other providers to see if they offer a better deal.

A 1035 exchange is just one way to turn your permanent life insurance policy into a source of income in retirement. Permanent life insurance has two parts: the death benefit and the cash value, a savings account that’s funded with a portion of your premiums. You can withdraw the amount in the cash value account at any time, tax-free. In a market downturn, you could use this money as a cash cushion until your portfolio recovers.

You can also borrow against your policy. Interest rates range from 5% to 8%, depending on market rates and whether the loan is fixed or variable. If you don't repay the loan, or you pay back only part of it, the balance will be deducted from your death benefit when you die.

If your insurance policy pays dividends, you can use them to ride out market downturns, says Dave Simbro, senior vice president at Northwestern Mutual. Instead of reinvesting the dividends in the policy, you can take them in cash, reducing or eliminating the need to withdraw money from your portfolio. Dividends typically range from about 4.9% to 6.4%. Any dividends you receive up to the policy's cost basis are tax-free; those that exceed that amount are taxable.

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