For most retirees, maximizing the amount of income they can take from their portfolio with minimal tax implications is their main financial objective. This is the one thing that makes everything else possible.
Being able to enjoy time with grandchildren, play golf or travel and secure your savings against the need for long-term care all hinges on your ability to convert your retirement nest egg into income that will last you and your spouse for a lifetime.
In other words, you need a secure income beyond Social Security and your required minimum withdrawals from your retirement accounts. Fortunately, you can create your own pension.
Lifetime income annuities
Lifetime income annuities take a lump sum and convert it into a stream of income that will pay you until your last day. They are simply contracts with an insurance company: You pay a premium and the insurance company guarantees a fixed income each month or year for as long as you — or you and one other individual (usually a spouse) — live.
Advantages
Peace of mind — The security of a lifetime income annuity may give you the confidence to seek greater returns in other parts of your portfolio, knowing that your basic monthly expenses are covered no matter what.
Predictable income — Lifetime income annuities generally allow for a higher steady monthly income than you can get from a bond or mutual fund portfolio alone without spending down principal. This is because of a concept called “mortality credits,” where income from those who die sooner than average is redistributed to those who live longer.
As a result, a lifetime income annuity can deliver a higher payout on a guaranteed basis than ordinary fixed annuities, CDs, money markets or income funds. In most cases, this payout is higher than that available from investment-grade bonds, though individual bonds can vary widely in terms of coupon payments and risk characteristics.
Tax deferral — You only pay taxes on the income attributable to growth in your annuity when you withdraw funds. The portion attributable to the return of your premiums is tax-free, so only part of your income from a lifetime income annuity is subject to income tax.
Asset protection — In some jurisdictions, lifetime income annuities may provide asset protection benefits. If you run into financial problems, creditors generally cannot touch your principal in a lifetime income annuity. You own a stream of income rather than a lump sum, which makes it difficult for creditors to collect.
Disadvantages
Irrevocable decision — Because commitment to a lifetime income annuity is generally irrevocable, it is not advisable to put a substantial portion of your funds into an annuity. Consider keeping enough cash or other liquid assets in case of a personal financial emergency.
Some annuity contracts provide for one or two accelerated payments of several months’ worth of income, but individual contracts vary widely in this feature.
Annuity is limited to you and/or spouse — Any assets you contribute to a lifetime income annuity for yourself and/or your spouse are generally lost to future generations. If you die early, the insurance company may keep the remaining value. However, most annuities provide a death benefit. Your heirs will receive the full amount you paid in minus any benefits paid to you though specific terms depend on the contract, riders and payout option.
Insurer risk — All benefits in an annuity contract are subject to the claims-paying ability of the insurance company. If the insurance company becomes insolvent, your benefits could be interrupted or reduced.
The takeaway
If you are retired or planning for your retirement, a lifetime income annuity is one of the most important tools in your kit. We can help you decide if an annuity is right for your circumstances.
