One flaw with traditional retirement planning is the assumption that your expenses – the type and amount — will be the same (plus inflation) each year, from your final day at work to the end of your life, and that all you have to do is “replace a percentage of your pre-retirement income.” As people live longer, we have proof that isn’t true. Healthcare costs, especially, increase in our late retirement years, and if we don’t plan for them, we risk running out of money.
The solution is to consider retirement as a two-stage process. In the first stage, you do want to cover a reasonable percentage of the final salary you earned before retiring, although the percentage may need to be more than 100%. Your Social Security payments, any pension, interest/dividends and payments from income annuities ideally will cover that. If you need to withdraw principal, make sure it’s for a temporary period and from a secure source.
For the second stage, you will want to maintain those payments to meet your essential living expenses – and add another level of income to cover the gap for things like home healthcare and additional costs that occur as we age.
A QLAC for the second stage
Where to you find income for a two-stage retirement? One answer is a product called a Qualifying Longevity Annuity Contract, or QLAC. It is a deferred income annuity that you buy when you are younger so that you receive predictable and guaranteed payments later in life, say at age 80 or 85. You can pay for a QLAC with money from your 401(k) or rollover IRA, and in the process eliminate taxable distributions. (A version of a deferred income annuity can be purchased out of your personal or non-qualified savings.)
The reason to make such a purchase is to convert your savings into guaranteed lifetime income at a future date you select. Instead of taking the risk that you will deplete your money as you live longer, you spend a portion of your savings now to ensure payments later. Doing so helps maintain your independence and allows you to make decisions about how you want to spend your time and resources late in retirement. Let’s face it: your financial advisor isn’t going to be around to give you guidance. And you don’t want to become a burden for your children.
There are some critics of deferred income annuities. Some say that you might not live long enough to collect your annuity payments. (By the way, that’s also true of long-term care insurance.) However, you can have the premium you paid go to a beneficiary if you die before the annuity starts. That option does reduce your payout, though — maybe as much as 25% or more.
Others criticize deferred income annuities because of the potential to eat into the financial legacy you leave your children or grandchildren. Here’s another way to think about it: Ensuring that you have enough money to pay your own way in late retirement is a gift to your children. It’s a smart trade to give up some wealth when you are relatively young to avoid running out of money during the second stage of retirement. Gaining financial confidence through your lifetime will also allow you to invest your remaining assets more aggressively.
When you explain your thinking to your kids, including your needs and objectives, they will have every reason to be delighted with your decision.
My website, Go2Income, provides more information about QLAC and deferred income annuities as well as immediate annuities. Understanding more about annuities can enable you to create the dependable, spendable income that will best serve you and your family.