With interest rates at historic lows, retirement income has become difficult to secure and now planners and retirees are even rethinking the role of the venerable annuity, which has long been a stalwart source of monthly income.
The plain truth is that unless you have boatloads of cash simple annuities alone won’t get the job done.
Consider a 65-year-old couple with pre-retirement household income of $75,000. This couple wants to replace 70% of that income in retirement, which comes to $52,500. To purchase that much guaranteed income through an immediate fixed annuity that pays until both have passed away, the couple would need to shell out nearly $900,000.
With other income sources like Social Security, they may be able to hit their income target with fixed annuities for a third less. But that’s still a hefty $600,000. If they are lucky enough to have a private pension they can chip away at that figure even more. But private pensions are fast becoming a relic.
The cost of a lifetime income stream purchased through fixed annuities is partly a function of market interest rates. As rates drop, newly purchased fixed annuities provide less monthly income for the same amount of money.
For that reason, a large swath of the population – those in or near retirement – were less than enthused when Fed Chief Ben Bernanke recently said he would dust off the “twist” maneuver. For one thing, this language induces nightmares of Chubby Checker and a 1960s dance craze best forgotten. More importantly, it brings on a migraine just thinking about interest rates (and interest income) falling further, which is the goal of the Fed’s financial play that involves selling short-term bills and buying long-term bonds.
Annuities can and probably should still play a role. But with guaranteed income so expensive to purchase, you may need to refigure how much income you absolutely must have. Instead of counting on annuities to provide income for your entire lifestyle, consider using them to cover only the costs of bare bones expenses like utilities, taxes, insurance, rent and groceries. If you could get those down to, say, $1,200 a month above and beyond your Social Security benefits, you’d need an immediate fixed annuity of only $240,000.
With the basics covered, you know you can weather any storm. What’s left of your nest egg will need to be invested slightly more aggressively, in dividend-paying stocks, Real Estate Investment Trusts, top-rated bonds or other reasonably safe assets that pay a decent yield.
If you are set on making fixed annuities a bigger part of your retirement plan, consider building them over five years so that you do not lock up all of your money while rates are this low. And keep in mind that many financial planners now advise stashing your money in banks CDs and simply living on less until rates rise and annuities provide more bang for the buck.