Almost every working person in America is, in some way, planning for retirement. Most of us are aware that traditional sources of retirement income, such as Social Security or an employer-sponsored pension, probably won’t fully fund our retirement as they did for past generations. More and more it’s up to us to prepare financially for our retirement years. As we build our personal retirement assets, we generally estimate our needs based on the cost of our expected or desired retirement lifestyle, the current outlook for inflation, what we can afford to save currently, and our estimated life expectancy.
But what if one or more of these factors prove to be other than anticipated and the money doesn’t last? People are living longer today, and it’s especially necessary to plan for the possibility of a longer life span. What if you run out of retirement savings at age 85 and live 10 or 20 more years?
Ensuring that retirement savings last long enough is where annuitization comes in. Annuitization, available through insurance contracts called annuities, guarantees the annuity owner income payments for a pre-defined period of time, typically ranging from as short as five years to as long as the lifetime of the owner and his or her spouse. Additionally, many financial advisors consider this an excellent method of building future income because annuities are tax-advantaged investments—that is, their assets grow on a tax-deferred basis during what’s called the initial “accumulation phase.”
How does an investor fund annuitization? First, assets are invested and built up for a number of years in an annuity during the accumulation phase. As an example, a 55-year-old man places assets into an annuity to begin the accumulation phase. When he turns 75, he decides how long he wishes to receive payments and “annuitize” his annuity contract. Thus, he begins his “income phase” of the contract and starts receiving a check every month. If he elects a lifetime payout, he receives checks for the rest of his life, regardless of how long he lives.
How assets build during the accumulation phase depends on which annuity you purchase. There are many types of annuities from which to choose. Fixed annuities guarantee a fixed rate of return, while variable annuities offer professionally managed portfolios that usually invest in the stock market. Most variable annuities provide a range of features and benefits, including provisions for your heirs in the event of your death.
All offer the advantage of tax deferral on investment earnings, which, over the long term, can represent a significant increase in value over investments with earnings subject to annual taxes. As with other investments, diversifying assets can provide a desirable mix of liquidity, stability, lifetime income, and opportunity for growth.
One of the greatest advantages of annuitization is that you don’t have to know in advance low long you’ll require income. Therefore, you can rest a little easier knowing you’ll have at least one source of ongoing income throughout your retirement years. IBI