2 ways to a more secure retirement

September 10, 2015
By: Jeff Kelly

Article originally published http://money.cnn.com/2015/09/09/retirement/guaranteed-retirement-income/index.html?sr=fbmoney091015retirement530story

When it comes to annuities, the variety and complexity of choices can be confusing. But for anyone who's retired or approaching retirement looking to turn a portion of their nest egg into guaranteed lifetime income, I believe the choice comes down to two types: an immediate annuity or a longevity annuity.

Compared to other annuities at least, both immediate and longevity annuities are relatively easy to understand. What's more, recent research studies have concluded that both of these annuities can actually enhance one's retirement security.

Immediate annuities, also known as SPIAs (single premium immediate annuities), could hardly be simpler in concept. You give an insurer a lump sum of money (the premium) and in return you get a monthly payment for as long as you live, regardless of how the financial markets are behaving. Today, a 65-year-old man who invests $100,000 in an immediate annuity would receive roughly $565 a month for life, a 65-year-old woman would get about $545 a month and 65-year-old couple (man and woman) would collect about $480 a month as long as either is alive. (This annuity calculator can show you how much men, women and couples might receive for different premium amounts at different ages).

You may think that you could generate the same amount of income investing on your own. But you can't unless you take more risk (which raises the possibility of depleting your assets too soon). What gives the annuity its edge is that each annuity payment you receive contains not just interest and return of a portion of your principal but an extra "return" known as a mortality credit. Basically, this is money that would have gone to annuity owners who die early that can instead be paid to those who live long lives. (The actual payment doesn't change; rather, actuaries factor in an estimate of early deaths when calculating an annuity's guaranteed payment.)

An immediate annuity's ability to transfer money from people who die early to those who die late is largely the reason that a recent study concluded that while an annuity didn't always provide more retirement income than using the 4% rule or other type of systematic withdrawal, it did so often enough that "it is hard to argue against a significant and widespread role for immediate life annuities in the production of retirement income."

Immediate annuities also have drawbacks, however. If you die soon after purchasing an immediate annuity, you'll receive relatively little in monthly payments or, to put it another way, you'll be the one providing those mortality credits to annuity owners who live a long time.

To get the largest monthly payment, you must also agree to give up access to your money, which means it's no longer available for unanticipated expenses, emergencies or to pass on to your heirs. So devoting all or even most your nest egg to an immediate annuity wouldn't be a good move. Indeed, if Social Security (which is also essentially an annuity) is enough to cover all or most of your living expenses, you may not need an immediate annuity at all.

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