A reader recently asked how best to help her 80-year-old mother, a widow whose income is falling short of her expenses and who risks outliving her money. It's instructive to look at this situation because it may describe the circumstances of many boomers and their parents.
There's no one obvious solution to this dilemma, and the family will need to negotiate some conflicting goals to help their mother. Let's take a deeper look.
The mother -- we'll call her Mary -- has a Social Security income of about $1,500 per month and has drawn down her retirement savings to about $100,000. She's adamant about a few things:
- She doesn't want to invest in stocks, due to the risk and volatility.
- She wants to live on the interest earnings and not touch the principal so she can leave a legacy to her adult children.
- She's fiercely independent and doesn't want to move in with her adult children, even though they have offered this help.
- She's been burned by financial advisors who charged a lot for investments that have declined recently. As a result, she desires simple investments that don't require much attention.
Currently, Mary's savings are earning about 3 percent per year, which translates to an annual income of about $3,000 to supplement her Social Security income. Lately, her income hasn't covered her living expenses, and her adult children have been sending her money each month to help make ends meet.
So, what can Mary do to boost her income? Here are some possibilities:
- She could invest in a no-load mutual fund or exchange-traded fund (ETF) primarily invested in stocks with the hope that her investments will appreciate in value. The trouble is, most stock mutual funds are paying less than 2 percent in dividends, which would result in a decrease in her current income. And of course, it's always possible that her investments could depreciate instead of appreciate.
- She could invest in a high-yield fixed-income mutual fund or ETF, which currently earn about 4 percent to 5 percent per year. That would boost Mary's current income by $1,000 to $2,000 per year, but with this option, she runs the risk that interest rates could increase, causing a drop in the value of her investments. Another risk is that the income could drop if the economy tanks again.
- Similarly, Mary could invest in a no-load mutual fund or ETF of preferred stocks, which are also earning in the 4 percent to 5 percent range. Once again, this approach entails risk of losses.
- Finally, Mary could buy a simple immediate life annuity that pays her a fixed monthly income for the rest of her life, no matter how long she lives and no matter what happens in the economy. Then she -- and her family -- won't need to lift a finger to have that check deposited each month in her bank account. A recent estimate from Immediateannuities.com, a low-cost annuity bidding service, shows that $100,000 could buy an annual lifetime income of $10,392 (a 10.39 percent payout rate). This represents an increase of over $7,000 per year in her current income, easily closing the shortfall that now exists. As a result, her children would no longer need to send her money each month.
Note that the annuity mentioned here is a simple income annuity. It's not a high-cost deferred annuity with early payment penalties that often creates the bad press about annuities sold to the elderly.
This fourth option -- the annuity -- seems to solve this family's challenges, or does it?
One big negative is that when Mary dies, she would have no legacy to leave to her children, something she's very interested in. That's just the nature of a simple, low-cost income annuity. Fortunately, both of her adult children are very comfortable financially, and they've told her repeatedly that they don't need her financial legacy. In fact, it would help them more if they didn't need to send her money each month.
Another barrier to the annuity is the realization that Mary could die in the next few months or years, and not fully recover her $100,000 investment. On the other hand, she could live well beyond age 90, which means she would more than recoup her investment.
Once again, this is just the nature of a simple, low-cost income annuity: It's a basic bet about how long you'll live. Die soon and you lose, but live long and you win. But what's the worse outcome: Regret from the beyond that you died too soon to recoup your investment, or being alive and broke in your 90s?
If Mary was really concerned about this possibility, she could buy an annuity with a reduced payout rate that guarantees payments for five or 10 years even if she dies within these periods. This type of annuity could still close the gap between her living expenses and her current income.
Some people worry about the insurance company going bankrupt, but state guaranty associations will cover most, if not all, of a $100,000 annuity contract.
One more possibility: Mary doesn't need to devote all of her $100,000 in savings to an annuity. It might make sense to devote half of her retirement savings to an annuity and invest the other half as described above to realize the advantages of each approach.
If none of these options appeals to Mary, she may have to reconsider whether she would move in with one of her adult children.
It would be best if Mary consulted with her adult children about the optimum course of action, so the entire family could be on board with the best decision for all concerned.