How a Life Annuity Can Reduce Retirement Costs

One question that baby boomers should ask themselves and answer honestly is, "Do I have enough money for retirement or do I risk outliving my nest egg?"

The answer is never simple, and it is almost impossible to calculate an accurate figure due to variables like healthcare costs, taxes, emergency expenses, and the performance of financial markets. Problems arise when you think you have enough money for retirement but you really don’t, especially you leave yourself vulnerable to running out of income. In some cases, buying a life annuity can be a simple yet effective part of the solution.

If you're new to annuities, check out our Frequently Asked Questions.

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When A Lifetime Annuity Makes Sense

We'll stick to the basics and keep the math simple. Let's assume you are 65 years old and getting ready to retire this year. You are expecting to receive income from a pension and social security, but you think you will need an additional $1,000 per month for the rest of your life.

So how much money do you need now to generate a $1,000 a month for the rest of your life?

In order to find an answer you need to estimate your return on investments and time horizon. In other words, what kind of return can you expect from your money and how long will you need this additional income? Let’s look at the numbers.

We'll asssume you're a 65 year old man who expects to earn 2.00% in an investment account you can easily withdraw from. We'll also assume you're going to live approximately 18 more years to the average male life expectancy of 83 years. In order to withdraw $1,000 each month you would need roughly $192,000. If you exceeed your life expectancy and make it to the ripe old age of 90 you would need approximately $240,000.

While you might think that 2.00% is too low a rate to use in these calculations, you need an investment you can withdraw princpal and interest from each month. And in the current financial environment, rates have been down for quite some time.

As a comparison, the cost of a single premium immediate annuity that would pay you $1,000 per month for as long as you live is approximately $185,000. Not only that, but if you live longer than your life expectancy, your annuity continues at no additional cost to you. It lasts your entire lifetime. If you're wondering how much you could make each month, use the blue annuity calculator on this page for a free instant annuity quote.

These numbers show just how important retirement planning is. Low returns can require more of a nest egg than you planned for, and what happens if you live longer than expected. That's why some people choose to go with an immediate annuity. The payments last your lifetime, are guaranteed, and can be a positive part of your retirement portfolio.

What Financial Advisors Are Saying

Now let's look at what many financial advisors are telling investors. They often repeat the mantra that taking on more risk for higher returns can help drive down the lump sum needed to generate income for retirement.

As an example, if you invest more aggressively with equity-based mutual funds, you could use a higher average rate of return, such as 5.00%. The lump sum required to hit that $1,000 a month would drop to $152,000 to get to life expectancy.

These figures are certainly more enticing than those assuming a 2.00% return. The problem is that these numbers are not guaranteed and carry much more risk. If markets tumble, you may be forced to take money out at a decreased "share value" (meaning you're using more of your holdings to get the same income - this is bad), or you may not be able to withdraw as much as you need - also bad.

If you plan your retirement assuming that you will get the higher 5.00% return, you must be prepared for economic downturns and the possibility your earnings may not pan out every year. This type of financial strategy is not guaranteed, and you might find your retirement finances not performing as well as you need.

On the other hand, spending $185,000 for a life annuity will guarantee your retirement income. This comes at a loss of access to this money, but you don’t have to worry about financial markets or predict how long you will live. The payments will continue as long as you do.

How to fund your retirement and protect yourself financially is an important part of planning your future. Basing your entire retirement plan on assumptions about future rates of return can be dangerous, leaving you seriously underfunded when you need income the most. A lifetime annuity is a cost effective, safe way to convert some of your finances into a guaranteed lifetime income stream.