Retirement income scorecard: Immediate annuities


(MoneyWatch) In the third part of our series this week on how to estimate your future retirement income, let's turn our attention to immediate annuities, which are one of three ways to generate a paycheck from your retirement savings. (For background on these methods, you may want to review my recent post, "3 ways to turn your IRA and 401(k) into a lifetime retirement paycheck.")

Retirement income generator (RIG) #3: Immediate annuities

With an immediate annuity, you give your retirement savings to an insurance company, and it promises to pay you a monthly retirement income for the rest of your life (no matter how long you live). You can continue the income flow for your spouse or partner after you die by using a joint and survivor annuity.

The amount of income this method generates will vary depending on the type of annuity you purchase, as well as your age, sex, and marital status. To provide more of an across-the-board look at this method, I've shown the results for fixed annuities, variable annuities, guaranteed lifetime withdrawal benefits (GLWB) and inflation-adjusted annuities.

Below are the annual incomes generated for a single man, a single woman and a married couple at three different ages. I've used annuity purchase rates at the beginning of January 2013, assuming you have $100,000 to buy the annuity. I've included the annual payout rates in order to compare immediate annuities to other methods of generating retirement income. These payout rates are not to be confused with investment rates of returns.

Compared to annuity rates offered at the beginning of October, fixed annuity rates have improved slightly while inflation-adjusted rates have worsened slightly. Variable annuity rates and GLWB payout rates have remained unchanged.

If you compare the retirement income amounts generated by the three methods I've described in this and the two previous posts, you'll see a wide range of results, depending on the method you use and your individual circumstances. In particular, you'll see that immediate fixed and variable annuities usually provide a higher initial retirement paycheck than systematic withdrawals or depending only on interest and dividends.

It's particularly helpful to compare inflation-adjusted annuities with the "4 percent rule," which is an application of systematic withdrawals often recommended by financial planners. For retirements at age 65, inflation-adjusted annuities have slightly higher payouts compared to the 4 percent rule for single men. The initial payout rates for single women are roughly equal, and the payout rates for married couples are lower with inflation-adjusted annuities. But keep in mind that the 4 percent rule has been questioned lately as possibly being too high, considering the current low interest rate environment and the significant fees for investment managers and financial advisors. If you use a 3.5 percent withdrawal rate with systematic withdrawals, inflation-adjusted annuities compare more favorably.

With inflation-adjusted annuities, you're guaranteed that your income lasts for the rest of your life and is adjusted for inflation, no matter how long you live and no matter what happens in the stock and bond markets. With systematic withdrawals, you hope to achieve these outcomes, but there's no guarantee, particularly if you suffer poor investment returns or live a long time.

The big tradeoff with most immediate annuities is that you generally give irrevocable control of your savings to the insurance company, while with systematic withdrawals you have the flexibility to tap into your savings. And with most annuities, there's no money left for a legacy after you and your beneficiary die; with systematic withdrawals, you can leave a legacy with any money left in your accounts when you die. Note that GLWB annuities are the exception to the above statements about annuities, and they offer the ability to tap into your savings and the potential to leave a legacy with any money left over after you die. But there's a tradeoff, since GLWB annuities have lower payout rates than fixed or variable annuities.

When it comes to generating a retirement paycheck that will last the rest of your life, there's no single answer that is appropriate for everybody. Your answer depends on your goals and circumstances. I often recommend that you split your retirement savings between annuities and systematic withdrawals, so that you diversify your retirement income and realize the advantages of each method.

Please note that the incomes shown above are pre-tax amounts. Federal and state income taxes will have a significant effect on your after-tax income and should be taken into account. The income taxes you pay will vary depending on whether your annuity was purchased with pre-tax investments in traditional IRA or 401(k) accounts, or with after-tax investments.

Because only you know which method or combination of methods might work best for you, you should take the time to learn as much as you can about the various methods of generating a retirement paycheck. (A good source to learn more about these methods is my recent book "Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck.") You'll thank yourself when you reach your 80s and 90s and your retirement income keeps chugging along.

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.