Last For A Lifetime. Making Your Money. Why You Need to Know About Annuities

Transcription

1 Making Your Money Last For A Lifetie Why You Need to Know About Annuities A Joint Project of The Actuarial Foundation and WISER, the Woen s Institute for a Secure Retireent

2 Acknowledgeents Special thanks to Anna Rappaport, Dick Schreitueller and Ron Gebhardtsbauer and the Actuarial Foundation s Task Force on Annuity Education. And to Pat Huphlett, Rachel Sotsky, Bobbi Munson, and Margaret Scott. A Joint Project of The Actuarial Foundation and WISER, the Woen s Institute for a Secure Retireent The Actuarial Foundation, a 501(c)(3) organization, was established in 1994 to help facilitate and broaden the profession s contribution to society. The Foundation explores innovative ways to apply actuarial skills in the public interest and brings together broad partnerships of individuals and organizations to address social probles in creative ways. WISER is a 501(c)(3) organization, established in 1996 by the Heinz Faily Philanthropies to iprove the opportunities for woen to secure retireent incoe. 2008, 2007, 2003 WISER and The Actuarial Foundation This booklet is intended to provide general inforation and should not be used as a substitute for legal or other professional advice.

3 A Guide to this booklet Introduction...1 The Road to a Secure Retireent Planning for the Journey Ahead Retireent Needs Survivor Issues Life Expectancy Inflation Health Costs How to Manage Your Retireent Savings...10 Iediate Annuities...12 How they work...12 They ight be right for you if:...13 What fors of annuities are available?...16 When should I buy an annuity?...17 How uch annuity do I need?...17 How do I shop for an annuity?...18 A checklist...19 To get ore inforation on buying an annuity...20 Tax issues...21 Mo, take care of yourself, don t leave e any oney...22 Getting Your Ducks in a Row: Taking your oney out coparing 2 strategies...24 Chart: Add Up Your Sources of Retireent Incoe...26

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5 Making Your Money Last For A Lifetie Why You Need to Know About Annuities Introduction Most of us have seen ads and heard coercials telling us to get ready and start saving for our retireent years. But, what we do not hear uch about is the next stage, the tie when we reach our retireent age and have to figure out how to ake our savings last as long as we need it. Of course, in order to ake our oney last it would be helpful to be certain about how long our retireent will last. But none of us knows the answer to that larger question. Not only do we not know how long our retireent will last but there is no agic forula to help us coe up with the answers. Each individual and couple enters retireent in a different situation, and their futures will unfold differently. The ore you know about what you have and how to anage it, the better off you will be. This booklet provides inforation and guidelines for people on how to ake their savings last. It helps explain the iportant role that iediate annuities can play by stretching out your oney to ake sure it will last no atter how long you will live. 1

6 Planning Your Retireent Incoe Many Aericans use their retireent assets too quickly and later find out they have to cut back on necessities because they cannot afford a decent standard of living. This outcoe can be particularly difficult for woen because they often live longer than en. In fact, arried couples soeties fail to adequately plan for the tie when one of the is living alone and their incoe fro pensions and Social Security ay be less. Meanwhile, others ay be too conservative about spending their retireent savings, and later find they could have lived ore cofortably. Soehow, retirees need to steer a safe path between these two ajor pitfalls: running out of oney or, perhaps a lesser evil, living below the standard and depriving theselves of the things they wanted and could have afforded. 2

7 Annuities in a Nutshell There are any different annuities on the arket today. This is a quick reference, and uch ore inforation follows. This booklet focuses on: Iediate Annuities, which you can buy at or after retireent. The payents begin right away and will continue for as long as you live. Fixed Iediate Annuity the insurance copany invests the oney that you give it and pays you a fixed aount each onth. Variable Iediate Annuity the insurance copany will pay you incoe as long as you live, but aount will vary based on what you choose to invest it in, for exaple, the stock arket. Deferred Annuities, not discussed in this booklet, are investent products that accuulate oney over the years before retireent until future payent. 3

8 The road to a Secure Retireent Planning for the journey Ahead As you start down the path to retireent, you will need to answer several questions. Soe questions you can answer with certainty, while others are dependent on circustances that you cannot predict in the future. 1. Retireent Needs Any initial planning for retirees ust include an assessent of their needs for retireent incoe. A coonly accepted benchark is that retirees will need roughly 75-80% of the incoe they had while working. Depending on your circustances, however, you ay decide that you need closer to 90%. When you estiate your own expenses in retireent, reeber that soe of your expenses will decrease. For exaple, you won t have to pay Social Security taxes, or work-related expenses. However, other expenses prescription drugs, long-ter care insurance, and others ay go up considerably. 4

9 2. Survivor Issues When planning for retireent, it is very iportant that couples understand what incoe would be available to a surviving widow or widower. Nearly 85 percent of older arried woen outlive their husbands. Many woen face poverty for the first tie when their husbands die before the and one or ore sources of incoe stop or are reduced. A husband s pension is often reduced by half after he dies, and if the couple receives two Social Security benefits, the lower benefit is eliinated. Couples should consider what their current costs are, what their sources of incoe are, and how those factors will change in the event of the death of one spouse. An individual needs about 75% of the incoe of a couple to cover basic needs. 5

10 3. Life Expectancy No one knows how long his or her retireent incoe ust last. Life expectancy figures, though eaningful for a large group of people, ean very little for one or two individuals. As a general rule, woen live longer than en and therefore need ore retireent incoe. Once you have reached age 65, the table shows the percentage expected to survive to each of the ages listed. For exaple, about half of woen (51%) who reach age 65 can expect to live past 85. Survivors To Age Men Woen % 100%

11 If $10,000 will be worth: inflation At After 10 After 20 After 30 is Retireent years years years 3% $10,000 $7,441 $5,537 $4,120 5% $10,000 $6,139 $3,769 $2,314 7% $10,000 $5,083 $2,584 $1, Inflation Inflation is very difficult to predict. Retirees in the 1970s faced 7% inflation, in the 1980s 5% inflation, and in the 1990s 3% inflation. Over tie, these rates ake a big difference in what you ll be able to buy with a fixed incoe (see table above). Conservative investents such as CDs or oney arket funds cannot always keep up with inflation. Over the long ter, investents in the stock arket offer the greatest chance for higher returns, and therefore keeping up with inflation, but they also carry higher risk of loss. 7

12 Soe benefits and investents provide inflation protection: Social Security benefits autoatically increase each year. Soe traditional pension benefits are also increased each year but ost are not. Stock investents historically have stayed ahead of inflation but often lose oney in the short run, so they need to be used carefully. Inflation-indexed Treasury bonds or inflation-indexed annuities are new but are not widely used. Variable annuities invested in a stock arket portfolio, require careful shopping soe carry high costs/fees. 8

13 5. Health Care Costs Health care costs in retireent should not be overlooked. Health care costs, and prescription drug costs in particular, have risen uch faster than other costs. Here are soe points to consider: You usually can continue your eployer s health insurance for 18 onths by paying a group rate for COBRA coverage. Medicare coverage starts at 65. If you are eligible, it will pay part of your bills for hospital care (under Part A) and doctor s services (under Part B). You still ust take care of any deductibles, coinsurance, or costs that are beyond Medicare liits. At age 65, you can buy a Medicare suppleental policy, Medigap, to help pay covered and non-covered expenses, including prescription drugs. Before reaching age 65, you ay want to start getting inforation on rates for Medigap policies. Soe edical expenses fall outside of Medicare and Medigap, such as for dental care, eyeglasses, and hearing aids. Long-ter care insurance can cover a range of services for individuals who can no longer live independently. Medicare and health insurance plans don t cover these costs. Medicaid is available only if you have a very low incoe. 9

14 6. How to Manage Your Retireent Savings Once you have soe retireent savings, you need to consider how to ake your oney last through your retireent. Few of us have really thought about how to ake that oney last for perhaps 20 or 30 years after we stop working. Think of yourself at a fork in the road. You can choose to go in one of two directions. One road you can take will require you to establish a withdrawal progra for your retireent savings: Estiate how uch you can withdraw and spend fro your savings so that it will last the rest of your life. Invest the balance of your savings until you need it. The advantage of this ethod is that it gives you the freedo to invest your oney as you wish and the flexibility to respond to needs or opportunities that ay arise. Life is full of surprises (and surprise expenses), so you will need to re-evaluate your plan at least every few years. Estiated Aount You Can Withdraw Age Percent of Assets 50s 3-5% 60s 4-6% 70s 5-7% 80s 6-8% 90s 8-10% The table gives you an idea of how uch of your assets you can withdraw and spend each year so that your oney will last your entire lifetie. The figures are only an estiate because every individual s circustances will vary. 10

15 Or you can take the other road, and use soe of your oney to buy an iediate annuity: This will provide you with payents for the rest of your life. If you choose a fixed iediate annuity, you will receive a guaranteed aount of oney each onth. Soe suggest that you wait to buy an annuity until you re at least age 70. If you retire earlier, you get the flexibility of anaging your oney for a few years. 11

16 Iediate Annuities An annuity lets you convert all or part of your retireent savings to a guaranteed strea of lifetie incoe. This gives you the security of knowing that you will continue to receive oney each onth for the rest of your life even if you live to be 100 or older. The insurance copany takes on the risk of figuring out how to ake the oney last as long you will live, so that you don t have to worry about it. How they work You can buy an iediate annuity with funds available fro a 401(k) plan, IRA, savings account, life insurance policy, inheritance, or the sale of a hoe. An insurance copany that you select invests the oney and akes regular payents, either by check to you or by autoatic deposit to your bank or financial institution. You can choose how often you receive a payent: every onth, quarter, half-year, or year. The aount of incoe is based on the aount of oney that you have to buy it, plus a nuber of factors including your age, sex, incoe option selected, and interest rates at the tie of purchase. With a variable iediate annuity, the payents also are based on the perforance of investents you choose. 12

17 Iediate Annuities They ay be right for you if: You have retireent expenses not covered by onthly pension and Social Security benefits. An annuity can guarantee a regular onthly payent for the rest of your life, and it transfers the job of anaging your assets to the insurance copany so you don t have to worry about how uch oney you can withdraw each year fro your savings. However, if you have a large incoe to pay all your expenses, you ay not need an annuity. You have every expectation of living a long life. Most of us don t know and can only ake our plans based on reasonable expectations. An iediate annuity can be a good choice for individuals who are in good health. However, if you know (not think) that you won t live for any years, you ay want to anage the lup su yourself. 13

18 You want the certainty of knowing you won t outlive your eans. An annuity is the best way to be certain you will get payents for the rest of your life, no atter how long you live. Soe people worry they will die early and lose alost all that they paid for an annuity. An alternative is to get an annuity that is guaranteed to pay benefits for at least 5 or 10 years, which is explained in the next section. You ay or ay not be able to ake ore oney in the stock arket if you can live with the uncertainty, you can withdraw a certain aount of your oney each year fro your investents. The oney you would use to buy an annuity is for retireent, not for your heirs. The ore oney you leave in the pension plan, or use to buy an annuity, the less you have to pass on to your children. Annuities generally don t pay death benefits. However, if you kept your oney in a lup su and ade periodic withdrawals, and then lived for a very long tie, your heirs wouldn t get anything anyhow and ight end up supporting you. You have oney set aside or figured in your annual expenses for other ites. You should not put all of your retireent savings into an annuity. Keep soe oney set aside for expenses such as long-ter care insurance, Medigap insurance, prescription drugs or other unexpected costs. Also, ake sure you understand the ters of the annuity contract before you sign. However, soe people worry about having a lot of oney tied up in an annuity because they have less flexibility to deal with eergencies or special needs or interests. 14

19 As you get older, you want to take fewer risks with your oney. Soe financial advisors and insurance agents ay say they can do better for you than an iediate annuity. Make sure you understand the risks involved, because you ay have to take greater risks with your oney in order to do better than an annuity. A financial advisor should provide you with a plan, and you should be cofortable with the risks and with the fees that you will pay the planner, either directly or fro your investents. Reeber, the financial advisor cannot guarantee results and you are the one taking the risk. If you have your retireent oney in an Individual Retireent Account (IRA) and are approaching (or over) age 70 1 / 2, you ay be concerned about the IRS rules that require you to take out soe of your oney. An annuity eets the Internal Revenue Service s (IRS) requireent that you start taking out a certain aount of oney each year. This requireent is called the iniu required distribution. 15

20 What fors of annuities are available? An optional for of pension or annuity can include lifetie benefits for a survivor, or can guarantee payents for at least a iniu period such as 10 years if you die soon after payents begin. The table below outlines several annuity options that are coonly offered, and gives an idea of the aount of the benefit for each option. These exaples use a $100,000 payent for a 65 year old couple. Payent Choices Incoe Option Lifetie Incoe, also called Life Incoe or Life Only pays you incoe for the rest of your life, and then the payents cease. Monthly Incoe* $794 per onth for life. Life With Period Certain pays you incoe for the rest of your life. If you die before the period certain, often 10 years, your beneficiary will receive the balance. Life With Refund Certain pays you incoe for the rest of your life. If you die before you receive the aount you paid in, your beneficiary will receive the balance of the aount paid in. Joint and Survivor lifetie incoe for two people. At the death of one person, the survivor will receive a percentage of the original aount, for exaple, 50% or 100%. $754 per onth for life, 120 onth iniu. $743 per onth for life, 135 onth iniu. $646 per onth, as long as one person is alive, under the 100% option. These figures are based on 6% interest and representative ortality. Your actual incoe ay be different. 16

21 Other kinds of annuity options, soeties used to protect against inflation, provide autoatic annual benefit increases that are indexed to inflation. The design, cost, and availability of such annuity fors vary widely. When should I buy an annuity? Soe people suggest that you wait until you are between ages 70 and 80 to buy your annuity, because you get a better deal fro the insurance copany. Just ake sure you don t spend too uch oney before then. How uch annuity do I need? Estiate your annual expenses in retireent. Reeber that soe of your expenses will go down. You won t have to pay Social Security taxes, you won t need to pay workrelated expenses, and you probably won t need to save. However, be prepared for soe expenses to go up. Review the sources and aounts of retireent incoe that you listed on page 26. Subtract your onthly Social Security benefit fro your estiated onthly expenses. If you have an eployer pension that will pay a onthly incoe, also subtract that aount fro your onthly expenses. Subtract any other sources of incoe that will provide a onthly benefit. If you decide to buy an annuity, it should cover the reaining onthly expenses that will not be covered by Social Security and pension benefits. 17

22 What if your total incoe falls short of your needs? While you ay not like these solutions, if you find that your incoe will not cover your expenses, there are several ways to fill the gap: Staying on your job a little longer can ean an increase in your pension and ore tie to build savings. Taking on either a part-tie or full-tie job will increase incoe. Consider ways to spend less, such as oving to a saller house or to a lower-cost area. Consider a reverse ortgage that can produce incoe without forcing you to ove out of your hoe. How do I shop for an annuity? The two ain criteria for coparing copanies when shopping for an annuity are price and safety. You will want to choose the annuity with the best price offered by the safest copanies. Start shopping before you re ready to buy, and get a sense of what the stronger copanies are offering. Don t worry if you find that prices are changing a bit they ay change for the better as you get older. 18

23 Here s a checklist you can follow in shopping for an annuity. Use a strong insurer Use a life insurance copany that has a strong financial rating. The annuity business is a long-ter arrangeent, and you want a copany that will always be around. Several insurance copany rating services easure financial strength and your public library can help you check rating inforation. Find good rates For fixed annuities, coparing rates aong different insurers requires little paperwork and no physical exa. For variable annuities, cost coparisons are uch ore coplex but are iportant, so ake sure you understand all of the fees and expenses. Check with your State Guaranty Association If an insurance copany goes under, State insurance guarantee funds ay continue to pay your annuity up to the state s axiu aount. You ay want to find out how this fund would cover your annuity contract, including any dollar liits that apply; soe of these state funds do not guarantee an insured annuity value that exceeds $100,

24 Where to get ore inforation on buying an iediate annuity You ay be able to find these sources in your public library or on the Internet. In addition, you can purchase the Annuity Shopper for $14 an issue by calling Rating agencies: The following private firs rate the financial strength of life insurers. A.M. Best Copany (abest.co) Moody s Investors Service (oodys.co) Standard & Poors Insurance Ratings Services (standardpoor.co) Weiss Ratings Inc. (weissratings.co) Annuity rates and planning inforation: These Web sites are operated by organizations who sell annuities, and have inforation on rates that insurers have charged for iediate annuities, dollar liits of state guaranty funds, and IRS rules: Annuity.co IediateAnnuity.co 20

25 Tax issues This discussion covers highlights of certain tax rules for general guidance. Individual taxpayers, especially those with high incoe, should consult a qualified tax advisor. If you bought your iediate annuity with pre-tax dollars: For exaple, if you use oney that you had in a traditional Individual Retireent Account (IRA), the payents that you receive fro the annuity are fully taxable. If you bought your iediate annuity with post-tax dollars: However, if you use oney fro personal savings on which you have already paid incoe tax, the IRS treats part of each benefit as a tax-free return of principal (or the aount you paid in for the annuity), and part as taxable earnings. Once the entire principal has been paid back to you, your annuity payents are fully taxable. Depending on the state where you live after retireent, you ay also owe state incoe taxes. 21

26 Early distributions before age 59 1 /2 Benefits paid fro a qualified plan or IRA to an individual who has not reached age 59 1 /2, except certain early distributions peritted by IRS rules, are subject to a 10% excise tax (in addition to incoe tax). However, annuity payents (and other series of substantially equal periodic payents ) are not subject to the 10% penalty. Age 70 1 /2 iniu required distributions IRS rules require individuals who are age 70 1 /2 or older to start receiving payents fro certain pension plans and retireent accounts. Aounts paid under a single-life or joint-life iediate annuity usually will satisfy these IRS rules in a siple way that does not expose the annuitant to the 50% excise tax. Mo, take care of yourself, don t leave e any oney. by Ron Gebhardtsbauer, Senior Pension Fellow of the Aerican Acadey of Actuaries My o is 77 and she had oney in an Individual Retireent Account at the Savings & Loan. Once she turned 70 1 /2, she had to start taking a iniu onthly aount required by law. Basically, she has to take out enough so that she would epty the account over her lifetie. This aount changes each year as her life expectancy changes, and the aount of oney is less. 22

27 I told her she could get an annuity fro an insurance copany, which will always pay ore. She asked, How can an insurance copany beat the Savings & Loan? Insurers generally have high expenses. I agreed with her, but said that the insurance copany can still win it focuses all of o s oney on her, not on e as her heir, because, fortunately, I don t need it. Under her current payent syste, taking out the iniu required aount each year, she was taking out close to $3,000 a year, and this annual aount would soon begin to decrease. If she lived to 95, she would get only about $1,500 a year, and about $500 a year at 100. However, if the insurance copany had the oney, about $33,000, they would pay her about $4,000 each year. They would pay her that aount each year, even if she lived to 100 or beyond. It took a while, but y o finally bought the annuity, and she s glad she did. Her incoe is higher now, and she doesn t have to worry about it running out, even if she lives a long tie. 23

28 Getting Your Ducks in a Row Taking Your Money Out: Coparing Two Strategies Systeatic Withdrawals How does this ethod spread incoe over your life? Does it protect you against inflation? Is it flexible enough to eet your individual needs? Who ay not be happy with this ethod? You estiate how uch oney you can take out based on how you predict your investents will do and how long you will live. You ay outlive your oney. It depends on what you invest in, and how well it does. You have control over the investent and withdrawal of funds as your circustances and the econoy change. Also, you can buy an annuity at a later tie. Don t use this ethod if you re uncofortable about being responsible for the risks and rewards of anaging your assets. Who will be happy? People who like to anage their own finances and people with plenty of oney for all of their expenses. 24

29 Iediate Annuity An iediate annuity provides incoe that s spread over your future lifetie, no atter how long you live or what the econoy does. Fixed annuity payents will lose purchasing power with inflation. Variable annuity payents will vary depending on how well the investents do. The ters of an annuity contract are usually not subject to change once it s issued, so consider your options before you buy. People in poor health probably won t get their oney s worth fro an annuity. But soe copanies are willing to take poor health into consideration when pricing the annuity. Buying an annuity akes the ost sense for soeone who s older, in good health, and ready to transfer to an insurer the job of anaging assets. 25

30 Add Up Your Sources of Retireent Incoe The table below will help you identify all your sources of retireent incoe. It also will help you estiate what benefits will be available for as long as you Can you count on getting the incoe Source of incoe Monthly aount for life? A. Social Security $ Yes B. Eployer pension $ Yes if paid as onthly incoe C. Eployer savings plan $ * Yes account (401-k) * Enter the estiated if paid as guaranteed annuity incoe these onthly incoe funds could buy. D. Eployer pension or $ * Soe risk of running out of savings plan account * Enter the estiated oney, depending on if paid in a lup su that s annuity incoe these how well you anage rolled over to an IRA and invested funds could buy. investents and spending E. Part-tie work $ No. In later years you re unlikely to find a suitable job that you can perfor. How to Calculate Total fro all sources Aount Total Aount Initial incoe $ Add A, B, C, D, and E Incoe you can count on for life $ Add A, B, and C Incoe that can keep up with $ Add A and E, inflation aybe B, C, D 26

31 live, for your spouse as a widow or widower, and whether it will keep up with inflation. Will the incoe keep up with inflation? Yes Private plans usually do not. Public eployee plans often will. What is your plan s track record? Not usually. Aount is fixed unless you use a variable or indexed annuity. Can soe or all of the incoe continue to your surviving spouse? Yes, offset by other Social Security benefits payable to the survivor Yes, if you use a joint and survivor for Yes, if you use a joint and survivor for Depends on perforance of your investents and the econoy while you re retired Depends on how well you anage investents and spending during your lifetie Probably, as long as you keep working No 27

32 WISER s ission is to iprove the long-ter financial security of all woen through education and advocacy. WISER supports woen s opportunities to secure pensions and adequate retireent incoe through research, workshops and partnerships th Street NW Suite 700 Washington, DC fax: info@wiserwoen.org The Actuarial Foundation's Mission is to develop, fund and execute education and research progras that serve the public by harnessing the talents of actuaries.