My simple story to explain the situation, for example, I recently retired. I’ve worked my entire life and am now ready to relax and enjoy my retirement. I’m trying to figure out how much income I’ll be able to take in retirement without running out of money. My former employer’s 401k plan has $200,000 in it. I’m 65 years old, and my wife is 56, and I’d like to know that I’ll have enough income for the next 20 years, or my wife if I don’t live that long. When it comes to annuities, what are my options?
We have two options for you to think about. Each option has advantages and disadvantages, as with all investment planning, and it is my job to help you understand them.
Option 1: Lifetime Income
Several different types of annuities can help ensure that you and your beneficiaries have income for the rest of their lives. A “lifetime five” solution is one option. This is where you put your money into an annuity that is invested in a professionally managed stock and bond portfolio. The annuity company is in charge of investment decisions.
You are guaranteed to receive 5% of the original investment each year for the rest of your life and the life of your wife. You would both be eligible for this type of annuity because you are both over the age of 55. The minimum age is 55 years old. The annuity company guarantees that you will be able to receive an annual income payment of at least $200,000 x 5% = $10,000 for the rest of your life and the rest of your wife’s life.
This is the insurance company’s bare minimum guarantee. The minimum amount you can be paid every three years can also be increased with this annuity. For example, if you invest $200,000 and your portfolio grows to $215,000 in three years, your new minimum guarantee is $215,000 x 5% = $10,750. You’ve just been given a yearly raise of $750 for the rest of your lives.
Your portfolio, on the other hand, could drop to $190,000 in three years. There would be no stepped-up minimum guarantee, in this case, so you’d just get your original $200,000 x 5% = $10,000 per year for the rest of your lives. In three years, you’ll have another opportunity to increase your income stream.
Remember that you have the opportunity to increase the value of your account every three years, but the amount of your annual payout can only go up, not down.
“What if I need money in a hurry for an emergency?” you might wonder. You would be able to withdraw the value of your portfolio, less any withdrawals and penalties, in this situation. It will almost certainly have some value, but it may be less than your original investment due to market fluctuations and withdrawals. You may also be required to pay a surrender fee of up to 10%.
A steady stream of income for the rest of your life, with growth potential. (In this case, a minimum of $10,000 for the rest of your life.)
In income streams, you have upside potential but no downside risk.
Every three years, you can take advantage of market gains and potentially increase your income.
If your account value has increased after the surrender period (usually 7 to 10 years), you can opt-out of the contract and invest in another annuity. If you don’t want to wait another three years to increase your income, this could be advantageous.
If you live longer than 20 years, you will be guaranteed an income stream for the rest of your life, as well as for the rest of your wife’s life, regardless of how many years she lives after you die.
You will pay a surrender fee of up to 10% if you need to withdraw the entire amount of your money within the first 7 to 10 years of investing your money.
If you want to get out of an annuity contract because you need the money in a lump sum, your account value may be lower than when you started.
It is not free for the insurance company to provide this “income for life guaranteed benefit” regardless of the account value. To provide these guarantees, there are additional annual fees. Between 0.50 percent and 0.75 percent of the account’s value should be expected.
Option # 2: Earn money for the rest of your life or for the next 20 years, whichever comes first. (Instant Annuity)
We’re talking about an immediate annuity with this type of annuity. This is when you buy an annuity contract and annuitize it right away. Things are a little easier in this situation, but as we’ve seen, there’s a cost to the simplicity.
The main benefit of this type of contract is that the annual payout is higher than in the previous example. The immediate annuity quotes we get from annuity companies average out to $13,500 for a person with $200,000 to invest.
Let’s take a closer look at how this works. The annuity company will pay $13,500 every year for the rest of your life or 20 years, whichever comes first. If you live to be 90 years old, the annuity company will pay you $13,500 per year for the next 25 years. If you live only another 11 years before dying, his beneficiary (in this case, most likely his wife Emma) will receive the remaining 9 years of $13,500 in income payments and that will be the end of it. If the annuity company has not already paid out 20 years of payments, one of the beneficiaries will receive the remaining payments at the end of your life.
Assume you die 21 years after he begins this contract. There will be no more payments to anyone because the annuity company has kept its promise of a minimum of 20 years. Your wife will receive nothing because there will be no money left in the contract.
“What if I need to take the money out after 10 years to pay a medical bill?” you might wonder.
The answer is that you won’t be able to do so. There’s almost no way out of an immediate annuity contract once you’ve signed it. After you sign the paperwork, you will have no cash value. All the annuity company has to do is payout for 20 years, or for the rest of your life, whichever comes first. The contract is worthless once the annuity’s obligation has expired.
Known income stream for the duration of the owner’s life.
Start with a higher income stream that doesn’t fluctuate.
There are no worries about the underlying investments because the annuity company is in charge of them.
Guaranteed 20-year income stream; if the owner lives longer than 20 years, the annuity company will continue to pay the same amount until the owner dies.
You can not get your money back in lump sum form if you need it after investing it. Only the annuity payments are available to you.
Your beneficiary will not receive any money from this annuity if you live for 20 years or longer.
There is no way for you to increase your income. Your payments will remain unchanged and will not rise in line with inflation.
These are just two of the many options available to someone in a similar situation. Both annuities have advantages and disadvantages. It might be beneficial to speak with our local Denver, Colorado annuity consultant for more information.