Guaranteed Income -- for Life

My parents and I have been exploring some estate-planning options recently. They heard some presentations on equity-indexed annuities, and we decided to avoid those. (Read about why that's smart.) We also learned about a much less troublesome option -- the lifetime income annuity.

That's not necessarily for everyone, but it does warrant your consideration. A recent Wharton School/New York Life study concluded that "lifetime income annuities are the most cost-effective and secure asset class for generating guaranteed retirement income for life."

Here's the good side of income annuities: In exchange for a sizable chunk of your money, they'll provide you with an income -- for life. This is attractive because we don't know how long we'll live. You might have a solid portfolio upon retiring at age 65, but what if you end up living to age 105? Will it be able to support you for 40 years, instead of the 20 or so years you might more reasonably be expected to live?

Also, if you're investing mainly in stocks, you simply don't know how well they'll do in the future. Your future nest egg is far from certain. With income annuities, your income might well be lower than what you'd be able to withdraw from your stock/bond portfolio, but at least it will be guaranteed to last your whole life. You just can't count on stocks to perform when you want them to. Coca-Cola (NYSE: KO  ) stock has recently been trading at levels it saw a decade ago, while Wal-Mart (NYSE: WMT  ) shares are roughly where they were eight years ago.

Of course, there are downsides. When you spend money on an income annuity, you're losing control of that big chunk of moola. If you're a 60-year-old man in Maine, for example, one calculator I checked estimated that a $100,000 purchase would buy you roughly $7,000 per year. With $500,000, you'd get around $35,000. That might not seem like enough, but remember that it will likely be in addition to some Social Security payments and perhaps a pension or IRA withdrawals, too.

Another downside is that it eats up your estate. If you spend half of your nest egg on such an annuity, you'll be leaving a lot less to your heirs, although some plans offer guaranteed payout periods with payments flowing to beneficiaries if you die before the end of the promised term.

Some long-grumbled-about issues with income annuities have been addressed in recent years, so the drawbacks have actually decreased in number. For example, you can now buy annuities indexed for inflation. This can be critical, especially if you're buying while still relatively young, though of course it costs more. Some plans now permit you to tap your money in the event of emergencies, or to raise or lower your payments in the future.

What to do
So, should you rush out and put all your eggs in this basket? Of course not. But it might make sense, after some further research, to put a portion of your nest egg in one -- or more. In our Rule Your Retirement newsletter, I read John Greaney's take on them. (Rule Your Retirement is the retirement guidance resource I refer to most often. I encourage you to check it out for free.)

Greaney is no stranger to retirement issues -- he writes about them frequently and actually retired himself, at the age of 38! When addressing these annuities (which should not be confused with variable annuities, which are harder to say nice things about), he notes that, according to his calculations, a portfolio of 60% stock and 40% cash (or short-term bonds) will usually serve you better. But notice the word "usually." In some ways, this to-buy-or-not-to-buy decision comes down to your risk tolerance. If you want to play the odds, you might skip it. But for some peace of mind, you might consider it.

It can also make more sense if you're somewhat older, such as in your 60s or 70s. At that point, you're giving up less future stock market growth for your portfolio than if you diverted a big chunk of your nest egg into an annuity at age 50.

Greaney offered some good conclusions. For example, he suggests that with interest rates so low these days, it could make sense to hold out for higher rates in the future, when your dollars will buy you more future income. It's also important to buy from a company with high ratings -- you don't want your insurer (for this is an insurance product) to go belly up before you do. Greaney suggests possibly dividing your purchase among several insurers.

Learn much more about all things retirement (including stock and fund recommendations) in our Rule Your Retirement newsletter.

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