A guaranteed lifetime income is a compelling proposition. After all—who doesn’t love the idea of being set for life? After all, there’s no way to know for certain how long your money needs to last in retirement, so more is more. While it is impossible to know how long you’ll live, it IS possible to make sure you will receive (at least) a certain amount of income for the rest of your life. Especially in this age of rock-bottom interest rates and volatility, a lifetime income annuity can be a lifesaver for some retirees!
Single Premium Immediate Annuities (SPIAs) can provide this income, yet few people use them in their retirement strategies. How can you know if a lifetime income annuity makes sense for your situation? Let’s explore.
Taking Longevity Risk Out of the Equation
When it comes to money, there are many types of risk. One of the major risks involves timing. You might choose when you would like to retire… yet how long will you live? It’s impossible to “plan” for an unpredictable time frame. It’s even harder when investments provide unpredictable returns. And with the life expectancy for Americans on the rise, it’s essential to think about your on longevity.
Mortality risk is the risk of dying too young. It’s a risk that insurance companies take, and one that families must also consider. The loss of a parent, spouse, partner, or child can be devastating—especially when others depend on that person’s income or contributions. Having a life insurance policy can protect against this risk and provide some relief for family members.
Longevity risk is the risk of living too long—and potentially outliving your investments. Longevity risk makes you afraid to spend your own money. It represents the guessing game around how much you can afford to spend now versus how much you might need later. Oftentimes, you’re not considering this risk until you’re staring it down.
A long life is an amazing blessing, yet it can feel precarious when you’re living on a fixed amount of money. A sudden crash in the stock market could shatter your retirement nest egg. Dropping interest rates could compromise the cash flow you thought you could count on. Yet living to age 90, 100, or beyond can mean a lot less spendable income later in life—especially when inflation is considered.
By all means—build your retirement strategy around a long life! After all, it is your life; you should prepare to enjoy it for as long as you are able. Yet how do you begin to take that longevity risk out of the retirement equation? Since you can’t plan the exact time span of your retirement, you need to look toward products that guarantee a lifetime income.
Insurance Companies Are A Balanced Scale
Life insurance companies are the only companies that offer this kind of deal. Because these companies are on both sides of the risk—providing payouts to those who pass on, and income to those who live longer—they have built-in protection on either side. On one side, the risk is that someone passes on too soon. The other side of the risk is that someone lives too long. This keeps the companies well-balanced and allows them to assume all of this risk.
Now, don’t miss the significance of this for you and your family. Life insurance companies can protect you against longevity risk and mortality risk.
Everyone is familiar with the basic premise of life insurance. Aside from the many potential living benefits, when someone with life insurance dies, a death benefit is paid. The death benefit addresses mortality risk. An annuity, on the other hand, pays you for LIVING—regardless of how long you live. Annuities are the ultimate protection against longevity risk. (And as a bonus—there’s no physical exam required to qualify, as annuities are age-based.)
So… What is a Lifetime Income Annuity?
Let’s clarify some terms. A lifetime income annuity, or cash annuity, is one that pays an income stream for as long as you live. You purchase an annuity for a sum—then it pays you income.
An immediate annuity is an annuity in which the first periodic income payment is due one income payment interval after the date that you purchase the annuity. In layman’s terms, it pays out income immediately after you put the money in the product. You can receive payments monthly or annually.
And a single premium annuity? That just means that for one lump sum of premium (payment), you receive a lifetime income. No further premiums (contributions) are expected or due.
The big benefit of a lifetime income annuity? You’ll have an income stream for life—no matter how long you live. You know exactly how much you can count on receiving, month after month!
And there is another significant benefit. When you trade your premium for an income stream and you are 70 or 80 years old, the insurance company can safely afford to pay MORE than the typical “interest only” product. Therefore, annuities pay substantially MORE than bank CDs or treasury bills—without volatility or risk.
Breaking the 4% Rule
How much of your assets can you spend without running out of money? The general rule of thumb (though not without debate) has been the “4% rule.” Spend 4 percent of your assets each year, and despite market volatility, you’re not likely to run out of money.
Unfortunately, it’s hard for most people to live on only 4 percent of their assets. That’s only $40,000 of income for each million invested! And if you draw the money down faster—it may run out. Draw it down too fast, and the principal shrinks, along with your earnings.
What if you could count on 7 percent, 8 percent—perhaps even 9 percent or more—and know that the income stream would continue no matter what happened with the stock market or the economy? That’s exactly what a cash annuity does for you. When comparing potential annuities for a woman in her late seventies recently, we could get a benefit of 8.7 percent annually—guaranteed. That means that for every $100,000 premium, she could count on receiving nearly $8,700 annually. Rates are often even higher for men because of differing longevity expectations. (We can happily help you compare annuity rates.)
In his influential 1965 research paper, “Uncertain Lifetime, Life Insurance and the Theory of the Consumer,” Dr. Menahem Yaari popularized the concept of using annuities to solve the problem of longevity risk. Still studied and quoted by economists today, Yaari established that if one’s primary motive was to maximize cash flow, annuities should be the primary, even exclusive component of a consumer’s portfolio.
Today, Yaari’s math and analysis still stands. His paper remains one of the most cited works in the study and research of economics. Immediate annuities can and do solve the longevity risk equation.
Why Don’t More People Purchase Lifetime Income Annuities?
A TIAA-CREF study found that eighty-four percent of respondents said that receiving a guaranteed monthly paycheck during retirement is important to them, yet only fourteen percent have purchased an annuity. Why is that?
First off, by the time people are of an appropriate age to purchase an annuity, they’ve usually decided on another path. Often, their broker or planner has guided them in a different direction.
Annuities have a bad rap, and that’s because some annuities are problematic. Some annuities are very complicated, and perhaps you have heard warnings about high fees and low-interest returns. These are accurate critiques when referring to deferred annuities, rather than single premium immediate annuities. (We don’t recommend deferred annuities as a general rule, partly for these reasons. Plus, deferred annuities lock up your money for decades!) So the issue here is that people hear “annuities are bad” and they assume all annuities are the same.
Annuities can also be sold inappropriately. We don’t talk about cash annuities much simply because most of our clients are too young to purchase immediate annuities. If you are 50 or 60 years old, an annuity will not pay much income and it will not be nearly as effective. However, we think it’s important you know about them now so you can have the option in the future!
An annuity is a permanent decision, and that can feel scary. Once you annuitize, you can’t change your mind, remove your money, and put it elsewhere. (This is another reason we recommend annuitizing later in life… you maintain greater flexibility for longer.)
Inheriting Cash Annuities
Perhaps paying a large premium, not knowing how long you will live, feels like a risk. What if you pass away next year and the insurance company gets to “keep” the premium? Fortunately, it IS possible for your beneficiaries to “inherit” that income for a pre-determined length of time, say, for 10 years. There are also many other possibilities that involve beneficiaries—in return for a lower payout. The important thing to consider is the desire for cash flow now. For many, it makes sense to maximize the cash flow of your lifetime income annuity and leave other assets (if possible) to beneficiaries.
While the permanency and the premium can scare people away, what should draw them back is a guaranteed income not dependent on market returns or conditions. With an annuity, there’s no need to draw from an account that has already experienced a loss. It’s not necessary to take a reduction in income just to have enough for next year. There’s no stress about the future of your funds and no need to worry about market volatility or interest rates.
Clearly, an annuity can be an extremely valuable cornerstone of a retirement portfolio. Whether purchased with retirement plan money or with some of the cash value of a life insurance policy, consider how you can integrate the benefits of a lifetime income annuity.
Diversify Your Assets
You should not limit your retirement income strategy to one component. By adding a whole life insurance policy to your overall strategy, ideally in the earlier years of your working life, the policy’s cash value gives you leverage for a SPIA in later years. It can revolutionize the way you look at retirement.
Instead of HOPING to have funds to pass on to your heirs, why not CHOOSE exactly how much you want to leave? Identify the death benefit you wish to leave to heirs and annuitize (with a SPIA) the rest of the policy for yourself (and a spouse, if applicable).
Purchasing a life insurance policy gives you the flexibility to get both. You can save and build your cash value well beyond what you put into the premium, and you get a death benefit that passes to your heirs free of income and estate tax (in most cases). The policy then gives you the freedom and the leverage to buy yourself a guaranteed lifetime income. By tying these two assets together, you can create a lasting income stream without worrying about depleting your accounts, disinheriting your heirs, or how to put food on the table in years to come.
Can’t Life Insurance Create Income?
Unfortunately, we hear this a lot, and it’s a popular sentiment right now. People are convinced that they can simply borrow against the cash value of their whole life insurance to pull income in retirement.
Here’s the truth. While you certainly CAN borrow against the cash value of your whole life, we don’t think it’s the most sustainable option. The reason it’s unsustainable is because a policy loan is still a LOAN. This means that you owe a certain amount of interest to the insurance company for the money you borrow from them. While you can choose not to pay that loan, this puts your policy and cash value at risk of imploding if you rack up enough interest. Best case scenario, your outstanding loans simply reduce your death benefit, which is still not ideal if you were intending to leave a legacy.
While you may choose to fund a SPIA by making a withdrawal from your life insurance policy, you can be more deliberate about how much you take. This gives you a greater degree of control over how much income you receive, and how much you’re reducing your death benefit. That way, you can find a balance that suits you, without being at the mercy of accumulating interest rates.
Remember—whole life insurance can do a lot, yet it’s not magic. If something seems too good to be true, it’s time to investigate. And pulling out policy loans in retirement is certainly NOT an unlimited pool of money.
Modern Retirement “Planning” Fails Those Who Live Long Lives
Annuitizing your wealth in retirement has been put to the test again and again—the overwhelming result is that annuities are often EXACTLY the route you should take. And yet, so many people are employing problematic strategies that won’t deliver as much.
The glorified mix of stocks, bonds, and real estate can only take you so far in retirement. The assets on their own don’t stand up over time because of the unpredictability of the market. If you live too long, the money depletes because of the natural course of withdrawals, especially during losses. If you’re caught withdrawing during an extended “bear” market, your funds will run out quickly.
Putting money into a single premium immediate annuity that pays out over an extended amount of time, on the other hand, is not dependent on those same things. It’s an asset in which the life insurance company—not you—bears the risk. Some of you may pass on sooner, and some of you may live for years to come. The premium paid allows the company to pay out an income stream no matter what.
A Lifetime Income Annuity Isn’t for Everyone
You may still wonder—is a lifetime income annuity for me?
If your primary goal is leaving the maximum legacy for heirs and beneficiaries, annuities aren’t the right vehicle. If you already have a healthy income stream, say, from a string of rental homes with double-digit returns, an annuity won’t be that attractive. They aren’t for everyone. Yet for the average American wanting to stretch their retirement income, immediate annuities provide excellent cash flow with maximum certainty!
The litmus test, truly, is in your age. For those under 70, it may be too soon to consider a SPIA. You’d have to pay an extraordinary premium to create the income you desire over what could be several decades.
For those of age 70-75, or above, it’s likely the PERFECT time to think about annuitizing your wealth. It’s all to do with age—and this range is right in the sweet spot. You’re in a place where you’ve got wealth, and you likely have some years ahead of you, but you have not yet crossed the line into scarcity mode.
If you’re still on the fence, consider this: lifetime income annuities offer what mutual funds and managed money cannot: a guaranteed lifetime income. Like the other products a life insurance company provides, these SPIAs are INSURANCE. It’s insurance on your income—a guarantee that you will never be without an income. A stress-free, guaranteed income is priceless. And since lowering stress can lead to longevity—an annuity just might be the ticket to a long, happy life!
To find out more, contact Prosperity Thinkers today. We can help you employ high cash value life insurance as an alternative for cash or if you (or your parents?) are over age 70, we’d be happy to provide lifetime income annuity quotes!
Disclosure: Our content is meant for educational purposes only. While it’s our goal to help you learn about building a life of prosperity, we do not intend to provide financial advice. Please consult your financial, tax or legal advisor before making any investment or financial decisions.