'Life Annuity' Could Be Answer if Outliving Your Cash a Worry
There are few more worrisome questions for retirees than this one: Will I outlive my money?
With Americans experiencing increasing longevity, disappearing corporate pensions, a fragile Social Security system and poor stock market returns in recent years, the question is growing more urgent.
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One answer could lie with a little-known insurance product called an "immediate income annuity," also known as a "life annuity."
You contribute a lump sum, say $100,000, and receive monthly income for the rest of your life. The income is determined by your age (and therefore your life expectancy) when you begin withdrawing the money.
Instead of continuing to manage the $200,000 in your 401(k) upon your retirement at age 67, for example, you could instead annuitize it, in effect creating a do-it-yourself pension.
Hersh Stern, founder and president of ImmediateAnnuities.com and publisher of the Annuity Shopper magazine, believes they will prove popular because of the savings patterns of Americans.
"People have just not saved at the rate that equates with their expectations of spending and retirement," he says. "People are starting to realize that they're at risk." However, Stern says he often must educate consumers on the potential benefits of the immediate annuity, owing to the much-maligned reputation of its cousin, the variable annuity.
The variable annuity, also a contract sold by a life insurance company, allows the owner to build up investments tax-deferred over time, to be paid out later, usually in retirement. While these annuities might be right for some, they have been harshly criticized for their sometimes exorbitant sales commissions, high surrender charges and unscrupulous sales tactics.
Although immediate annuities tend to be more consumer-friendly, they are not for everyone. And even those who could benefit from them should tie up only part of their money in this way. That way they have cash available for emergencies and, if possible, something to leave to heirs.
Here's how they work.
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With a fixed-rate immediate annuity, the amount of the payment does not change. However, you can choose a graded payment option that lets you increase your payments gradually. You have several choices regarding how the money is paid out. You can elect to have regular payments for the rest of your life, or you can choose to have payments made to both you and then to a survivor, such as a spouse.
Another method is to opt for a fixed annuity with a guaranteed term of say 10 or 15 years. Should you die before the term ends, your beneficiaries receive the remaining payments.
If you choose an immediate lifetime annuity without any guarantee period, and die soon after signing the contract, generally the money you contributed goes to the insurance company and not to your inheritors.
When shopping for a fixed annuity, focus on two features: the payments and the credit quality of the insurance company. Go for the highest monthly or periodic payment and the highest credit rating.
Unlike variable annuities, which are backed by investments, fixed annuities become part of the insurer's general account and are backed by the insurance company itself. Therefore its creditworthiness is paramount.
Look for insurance companies with AA or A+ ratings or better from all credit rating companies. (More information on over a dozen annuity providers can be found at ImmediateAnnuities.com.)
Consumers will need to be educated that an annuity is not an investment, but an insurance product, says Stern. You buy it to remove a risk – longevity risk.
Many people see it as taking a gamble, that they'll either win by outliving their life expectancy or lose money to the insurer by dying early. By not using an annuity, however, says Stern, "You're betting that you're not going to live a long life. The annuity negates this risk. While I am alive, the annuity provides peace of mind that no matter how long I live or I and my spouse lives we will have an income."