“Guaranteed income for life” is a powerful phrase. It conveys a promise of a specific level of cash deposited monthly into your bank account – for the rest of your life. It’s not dependent on market results or swings in interest rates. And that income can continue to be received by a spouse once you’re gone or, in some cases, go to a separate beneficiary.
But while each method of acquiring guaranteed lifetime income – Social Security, a defined benefit pension, and an income annuity — has a different source, everyone planning for retirement can create plans based on one, two or all three of these reliable and irreplaceable sources of money.
How is it possible to guarantee a monthly paycheck for life?
Predictions regarding how long people will live do play a role, but the money has to come from somewhere. The process sometimes seems impenetrable when listening to CPAs or government officials, but in fact it is simple.
Nearly everyone in the U.S. who works can count on Social Security payments when they retire. This federal program is essentially a “pay-as-you go” system. As you undoubtedly well know, part of your paycheck, whether you work for someone else or are self-employed, goes toward a Social Security tax. You don’t get back the tax you paid. Instead, your payments and those of millions like you have gone into the Social Security system to be paid out to people who have already retired or are disabled.
The risk to guaranteed Social Security income for future retirees might come from a reduced worker population or medical breakthroughs that increase lifespans, with accompanying inaction from the government to make the necessary reforms to keep the system solvent.
Company and government pensions
If you were lucky enough to work for a company or a government organization that still had a defined pension plan during your working years, you will be able to rely on a pension providing lifetime income.
In past generations, nearly everyone who worked for a company earned a pension. Pensions are now nearly extinct. Instead, employees are offered a 401(k) plan as a savings vehicle, often with contributions from the employer.
Pension plans differ in their benefits. Some offer cost-of-living raises and many, but not all, continue paying to a spouse after the retired employee dies. Some plans also allow the pensioner to vary the size of the monthly paychecks.
Employees get great value from pension plans because they are provided by the company, which gives large amounts of money, based on actuarial analysis, to professional investment managers with the intent of paying future payouts. And if something goes drastically wrong, the Pension Benefit Guaranty Corporation will continue to fund payouts in some form.
In a 401(k), individual employees typically invest their savings in stock or bond funds and they bear the investment risk. Quite a bit of money can be accumulated, but if the investment accounts are continued into retirement the payouts are not guaranteed for life. These savings can be converted into an income annuity described below that can provide higher payouts that are guaranteed for life. Unfortunately, the income annuity option is not often actively promoted by sponsors of 401(k) plans.
The funding of an income annuity is a simple process: You pay a sum of money to a life insurance company to purchase a guaranteed amount of lifetime income.
From that point, your income annuity is fully funded. You don’t have to worry whether your former employer might go bankrupt, which could affect a pension, or whether the government will agree to make the necessary reforms to fund your payments, as with Social Security.
You paid the money and it will come back to you for as long as you live.
There is also plenty of flexibility with the form of the payments. You can start the income immediately, defer it to an age of your choosing, make sure it covers your spouse, and have it include cost-of-living increases.
Some people fund their income annuities from savings in a rollover IRA or their company 401(k). Others use personal savings or deferred annuities as the source of premiums.
Life insurance companies that sell income annuities are able to make payments to retirees by investing the money and pooling the longevity risk with other purchasers.
I advise people who buy income annuities only to purchase from insurance companies that earn an “A” or better from rating agencies. Most of these companies have been in business for 100 years or more, surviving through war and economic depressions.
For the most fortunate
In the best of all worlds, retirees are able to rely on all three sources of guaranteed lifetime income. But if you don’t have a pension, you know you can use Social Security as a base.
An income annuity will provide the same type of security. It’s your money, earned over many years of hard work to provide for you and your family. And it’s solely your decision about how to spend it.
Jerry offers many ways to learn more about income annuities and how they might help you fund retirement. Write to him at Ask Jerry and he will answer all of your questions. Or visit Go2Income.com and design an income annuity that fits your individual needs.