- 5-Minute Article
- Aug 20, 2018
Your Guide to Guaranteed Income
Plan for guaranteed income in your retirement years so you can focus on your passions with more confidence.
The years leading up to retirement are a time to begin planning for the switch from saving to spending your savings. Most people have always depended on a paycheck to cover expenses. Although that paycheck goes away when you retire, you’re still going to need a steady source of income. And it’s especially reassuring to have guaranteed sources of income you won’t outlive; life expectancies continue to increase (about one in every four of today’s 65-year-olds will live past age 901).
You’ll need to determine how you’ll start using your assets – guaranteed and non-guaranteed – to cover both essential and discretionary expenses in retirement. How long will you need your income to last after you retire? How will changes in the market impact your ability to draw on those assets? How can you ensure everyday expenses are covered so you can confidently do more of what you love?
Financial advisors can be a great resource for helping answer those questions, because they can guide you through the process of retirement income planning, explain the role guaranteed income can play, and demonstrate how annuities can provide benefits that other types of income sources don’t offer.
Retirement income planning is the process of assessing your mix of income sources in retirement, determining when and how you’ll draw from those sources, and identifying any potential gaps between expenses and income that an annuity could help bridge. Income sources may include:
- guaranteed income from Social Security, a pension, or annuity;
- variable income from investments;
- or direct income from a part-time job or other work.
Diversifying your sources of income in retirement is an important strategy. It means you’re not relying on just one source, which can expose you to risk if the market has a downturn, or – in the case of retirement plan accounts such as IRAs – require you to withdraw a certain amount each year after you reach age 70½. Diversifying income sources also means you have liquidity for emergency expenses and income you won’t outlive.
Think of retirement income planning as requiring money in three buckets:
1. Essential, day-to-day expenses.
Ideally, guaranteed income takes care of these costs, including food, shelter, and healthcare. Examples of guaranteed income include Social Security payments, pensions, and annuities. They bring an element of protection and stability to your financial plan by providing regular monthly income that you won’t outlive and won’t be affected by market changes
2. Discretionary expenses.
Using variable sources of non-guaranteed or variable income should cover discretionary costs, such as travel, pursuing a passion, or supporting charitable causes during retirement. A 401(k) plan, IRA, money market account, dividend-paying stocks, and mutual fund investments are typical examples of non-guaranteed income. These types of assets can increase or decrease in value as the market moves, but they historically perform well over the long haul, serving as a strategic buffer to inflation.
One factor to consider, however, is the effect a market downturn at the time you retire could have on how much income you receive from this bucket. A market swing early in retirement could make it difficult to recoup those losses in future years. In fact, your savings may never catch up to where they might have been without the market dip. This is why balancing non-guaranteed with guaranteed income sources can be so important. To help balance that out, note that variable income sources can be converted to guaranteed income. For example, you could use money from your retirement savings account to purchase an annuity.
3. Emergency fund.
Income sources in your emergency fund may fall within one of the other two buckets or be separate. Emergency funds can also include savings or income from part-time work. Your financial advisor can help determine how much you’ll need in this fund as part of your overall retirement income plan.
If your anticipated essential expenses will be higher than your Social Security and any pension income, an annuity can help fill the gap, providing guaranteed income for the rest of your life to help cover everyday costs and help protect against you outliving your savings. Knowing your fixed expenses are covered could allow you to pursue your passions in retirement with more confidence.
An annuity is purchased through a financial advisor or certified financial planner, who will work with you to make sure it’s a suitable choice for your retirement plan. You can purchase an annuity by taking a portion of your retirement savings and making one lump-sum payment or scheduled payments over an established period. In return, you receive a guaranteed income stream over a fixed period or for as long as you live. With most annuities, you’ll have the assurance that your monthly income payment won’t change, or that it won’t drop below a minimum amount.
|When you receive annuity payments|
|Annuity Type||Your Initial Premium||The annuity|
|Immediate||One lump sum||Begins payments to you within 12 months|
|Deferred||One lump sum or scheduled installments||Begins payments to you in the future at an agreed date|
Take this hypothetical example. Cynthia is 65 years old and about to enter retirement. After talking with her financial advisor, she has decided to use $100,000 of her retirement savings to buy a single premium immediate annuity – an annuity purchased with a single payment that begins paying income immediately. Based on her purchase payment of $100,000 and current rates, Cynthia will receive $491.20 of guaranteed income each month for the rest of her life, regardless of how long she lives or market volatility.2
In addition to guaranteed income, some annuities provide growth opportunities via a fixed interest rate, by investing your payments, or by tracking a market index such as the S&P 500. This growth is typically tax-deferred, meaning you won’t pay taxes on growth until you begin making withdrawals from the annuity. Once withdrawals begin, you would pay ordinary income taxes on the full amount withdrawn.
Another key consideration for whether an annuity fits in your individual plan is what kind of access you’ll need for your money. If your financial plan has liquid assets that can be immediately accessed in full, annuities may be a good complement. But they might not be a fit for someone without other sources of liquidity in their portfolio; most annuities are designed to be long-term, non-liquid products.
The ability to withdraw income varies by the type of annuity you select. Some types of annuities allow portions of the account value to be withdrawn for income needs, but you typically can’t withdraw the full account value without paying a withdrawal charge.
Annuities today feature considerable flexibility, ranging from how you pay for it, how you’ll get your lifetime income, and how payments change or stay the same if a spouse passes away. Given the many options that can come with annuity policies, they can also feel complex. Your financial advisor can help address your questions, as well as share a few factors to consider when thinking about purchasing an annuity.
Here are some questions to help begin a conversation with your financial advisor about your retirement income plan and annuities:
- How diverse is my retirement income mix? Do I have a balance of guaranteed income and nonguaranteed income suitable for the retirement I envision?
- Are my emergency savings sufficient?
- Will my essential expenses be covered with my existing guaranteed income sources? If not, what is the anticipated gap?
- Would an annuity strengthen my retirement income plan? How?
- Which type of annuity is right for me? Which features should I add for my needs?
- What percentage of my retirement assets should I consider spending to purchase an annuity?
- What are the pros and cons of annuities?
- What if my plans change and I need to adjust my retirement income plan? Can I restructure my annuity?
- What role do my taxes play in my retirement planning?