We talk all the time about the advantage of those that have a pension from their previous employer. Maybe you were a school employee or a federal, state, or local government employee, and you worked long enough to qualify for a pension. Maybe you have been fortunate enough to work at IBM, Lockheed Martin, or BAE while they still had their pension plans, so you are eligible for some pension income based on some years of service. Maybe you did twenty years of service in the military, and you are now eligible for a pension for your service.
The good news about a pension is that you have income that you know that you will get for the remainder of your life. While working, you did not have to pay into that pension or paid a small amount. Many individuals knowing they had that pension coming, chose to save less in their 401(k), 403(b), or 457 contributory plans. Many employees could retire early because they knew that pension income would be available. For many individuals, add in Social Security benefits, and they were coming close to or even receiving more in income from the pension and Social Security than they were from their wage income.
The downside to a pension – very few of them adjusts over time. If you retired at age 55 with a $65,000 pension, when you are age 85 your pension will still be $65,000. There is no increase for inflation over the years. Social Security does have a COLA increase each year. As quickly as their Social Security goes up, many will tell you that their Medicare premium also goes up, and the net does not allow them to keep up with the increases in the cost of expenses. Having other savings – in an employer plan or IRAs can help make up the difference.
That pension does create peace of mind. If you know that you will always have that dollar amount and the amount of Social Security, you can be freer with other savings since many, if not all, of your basic necessities, are taken care of.
If you were not fortunate to work somewhere that generated a pension, you could consider purchasing an annuity and creating your own “pension-like” payment. You can invest a lump sum, say $100,000, into an immediate annuity. This allows you to immediately start receiving a monthly payment that you can elect to receive for the rest of your life. The payment amount will vary between insurance companies and will be dependent upon your age when you start receiving the payments. The insurance company is taking a risk as to how long you will live. The older you are when the payments start, the higher the payment because they anticipate you have a shorter life span.
You, of course, are expecting a long life and hope the insurance company pays for many, many years. If your life expectancy turns out to be short, you took a risk and “lost” while the insurance company “won.” If you live that long life, you “won, “and the insurance company “lost.” In this case, the winning/losing is based on did you get enough in payments back to get your original amount invested and a decent rate of return out? You must realize that you can no longer receive any of the initial lump sum as a refund even if you live only a short time.
You can take some of the risks away of early death and the disappearance of an annuity payment by doing a life annuity payment with a period certain. A period certain requires the payment to continue for a certain number of years, even if you pass away early. You can elect a 5-year, 10-year, or even 20-year period certain. This rider to the policy says, if you pass away after 3 years and you chose a 10-year period certain, your named beneficiary will get the remaining 7 years of payments. If you chose a 10-year period certain and pass away in year 12, your beneficiary would receive no payment. By choosing a period certain option, you need to be aware that your monthly payment will be smaller because you wanted to reduce your risk.
Some annuities will allow you to add an inflation rider of up to 5% to the payment. If you chose a 3% inflation rider, it means each year on the anniversary of your policy, you would receive an increase in your payment of 3% – like the cost-of-living increases for Social Security. This can provide the comfort of knowing you are closer, if not keeping up with increases in the cost of living. Again, because the insurance company knows that payments will be going up, your initial payment will be smaller.
For many, knowing that they have this monthly payment for life allows them to be not quite so cautious with the remainder of their investments. If you know your annuity payment and Social Security will pay the majority, if not all, of your basic expenses, you may be willing to spend a little more on travel or your favorite hobby.
I often say, “I wish I had a crystal ball that tells me you are going to die on this day.” If we knew you were only going to live another 10 or 15 years, we could plan so that you were spending your last dollar on your last day. As it is, I am continually reminding people, “what if you live to be age 90 or 95 or even 100?” I do not want to be telling you at age 90 that you must go back to work because you are out of money. On the opposite side, we do not necessarily want you to minimize enjoying your retirement because you are concerned about whether you have enough funds to last your lifetime.
Like the pension, an annuity payment can alleviate some of that anxiety. What if you know that annuity payment and Social Security covered most of your expenses? Could you then think about spending a little more of your other savings early in retirement, knowing that you will slow down later in life?
In doing an annuity, you must remember that you are giving up the ability to use that lump sum of cash. You know, only have the rights to the monthly income. We strongly recommend that you do not put all your life savings into an annuity. You need a lump sum of cash available in case of an emergency. You may want a lump sum of cash available to allow for luxuries throughout your lifetime.
We also often use short-term period certain annuity payments rather than lifelong annuity payments to help maximize other sources of funds.
For example, maybe your want to retire at age 62. Rather than taking your Social Security and having the lifetime reduction of Social Security benefits for drawing it early, you do an 8-year period certain annuity. The annuity payments will be set to last from now until you turn age 70. At age 70, the annuity payments go away, and your Social Security payments will start. You avoided the 30% lifetime reduction in benefits for drawing early. Delaying the collection of Social Security means you increase your benefits by 8% for each year between your full retirement age until the time you turn age 70.
If you have a Social Security report, look at the difference between what you are eligible to collect at age 62, your full retirement age, and age 70. It is pretty significant. You are also “using up” some of your other income sources, which might allow you to have less taxable Social Security when you start collecting or maybe just reducing your required minimum distributions (RMDs) later in life.
Recently, we have had several individuals worried about when the stock market is going to crash. While we are not expecting that any time soon, we also know how determinantal it can be to a portfolio if you must take money out of your investment accounts while the stock market has declined significantly. Taking money out in a down stock market means selling more shares to get your distribution. When the stock market recovers, it takes more for your recovery because you have fewer shares to rebound.
Taking a portion of your funds out of the market and doing a period certain annuity for 5 or 10 years means you will have the monthly income you need to manage your lifestyle without touching the market-invested dollars. The funds that you have remaining in the stock market would have time to recover if a decline were to happen without you having to take money out to pay your expenses.
All this is saying is that annuities can have a place when planning your income strategy during retirement. They are not suitable for all your funds. You may not want to lose access to a large enough lump sum that would be required to cover all your basic living expenses, but maybe something for a portion of them. You are taking the risk as to whether you pass away early or live a long healthy life. The intent is you are reducing the risk of running out of money later in life, which hopefully reduces your stress level and gives you the peace to experience more in retirement.
If you think an annuity might be right for you or want to have a further discussion about whether you should consider one, please contact us at Planning with Purpose for a more personalized conversation.