Last Updated Aug 14, 2009 12:54 PM EDT
What is it? Guaranteed retirement income is basically what is called an immediate annuity. Here is how it generally works:
- You give a lump sum of money to an insurance company.
- The insurance company agrees to pay you a fixed amount every year for as long as you live.
- So if you live to 110, the insurance company has to pay you.
- But if you and your spouse die two years after buying the annuity, the insurance company keeps the money. That's the trade-off.
- That looks pretty good. But in order to evaluate whether this annuity payment makes sense, you should consider how you might do if you just kept the $1,000,000 invested in the markets and distributed the same $61,700 each year from your portfolio.
- Well, we can't predict the future, but in studying hypothetical historical returns in the stock and bond markets going back to the 1920s, you'd find that there was a better than 90% chance that if you took out $61,700 a year from a $1,000,000 balanced account, you would not have run out of money prior to the end of an assumed 30 year retirement.
- Although past performance is no guarantee of future returns, looking at the history of the markets helps you assess the risks associated with this level of income distribution from a portfolio.
- Compare that to the annuity, where the payment is fixed at $61,700 for life, and the insurance company benefits from any growth in the markets, not you.
- But of course, in less than 10% of the historical scenarios, you would have run out of money, so in those cases the annuity would have looked like a good deal. And since you don't know what the future holds, the annuity may offer additional comfort and risk management features.
- However, after last year's financial meltdown, you have to consider the possibility that your insurer could default on the income guarantee. Remember the guarantee is only as good as the company backing it.
- If you keep your money invested in the markets, you have the ability to make adjustments to your holdings if we do experience high inflation. And since inflation is generally the biggest threat to your retirement security, having that flexibility may prove very valuable in the future.
Bottom line. Retirement income strategies are complicated, but the decisions are incredibly important because they'll impact the quality and security of your retirement. So don't rush into anything, and be comfortable that you understand the benefits and burdens of any strategy you select.
As with all financial matters, consult your individual advisor prior to making any decisions. The examples in this post are hypothetical, and intended for educational purposes only.