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How to Buy Insurance for Your Retirement

By Matthew Frankel, CFP® – Mar 22, 2014 at 10:46AM

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Here is an excellent way to make sure your money lasts for as long as you do.

Photo: 401(K) 2013

One of the most common fears among retirees and the soon-to-be-retired is they will outlive their retirement savings. This is a very legitimate concern as more people are living into their 90s and even 100s than ever before.

However, there may be some relief for these worries. A deferred-income annuity can be used as a sort of "insurance" in case you live longer than you expect.

The problem
Let's say you plan to retire at 65, and you plan to have a total of $2 million in total savings during retirement. Using the "4% withdrawal rule" that is common among retirement planners; this translates to an annual income of $80,000 with increases for inflation each year, that should last for 30 years or more.

The concern is: What happens if it doesn't last? What if there is a severe recession, or even a depression along the way? What if your money lasts for 30 years as planned, and you end up living to be 105 years old? While there is an excellent chance your money will last as long as you need by withdrawing 4% annually, it is still just that, a chance.

What is a deferred-income annuity?
A deferred-income annuity basically means you give a company a sum of money now, or when you reach a certain age, in order to establish a pre-defined income stream later. The sooner you buy, and the later you hope to collect, the higher the eventual income will be.

Using a current chart of deferred-income annuity payouts, if you buy a $100,000 annuity when you are 55 that will begin paying out at age 75, your annual income (for life) after reaching 75 might be around $26,000. If you buy a similar annuity 10 years earlier, at 45, the annual income jumps to $42,000.

How much and when?
There is no definite answer to this that works for everyone, but the obvious guideline is you never want to run out of money or be forced to make significant cutbacks in your lifestyle. Let's take a look at our earlier example of a retiree that is expecting $80,000 in income from his savings each year.

A good "insurance policy" could be an annuity that kicks in at 80 years old, bought for $100,000. Out of a $2 million retirement nest egg, this isn't that significant, and can provide tremendous peace of mind in the even if things go poorly with your portfolio. Such an annuity purchased at age 55 would produce around $45,000 in annual income for life after age 80. If the annuity income were further delayed until 85 (your money should last this long unless something extreme happens), the annual payout jumps to $87,000, which would more than replace every dime of expected income.

Of course, we hope our portfolios will provide us with plenty of income for as long as we may live. If things go according to plan, an annuity like this could also provide a nice income bonus during your later years, more than enough for a few extra cruises or some serious spoiling of the grandkids.

Looking decades ahead
I generally don't advocate annuities as sound investment choices. In fact, I usually discourage people from getting involved in annuities because it's not too hard to get better returns elsewhere, and when you die, so does your nest egg.

However, the deferred-income annuities are not a bad idea as a supplement to a sound retirement plan. The peace of mind you will be taken care of even if you live to 120 is easily worth the small portion of your savings it will cost. If your main goal is to create a worry-free retirement for you and your spouse, a deferred-income annuity is certainly worth looking into.

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