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July 21, 2015

How to Make Your Retirement Income Last Forever

Over the last few years, I’ve spilled a lot of ink talking about how the Fed’s zero-interest-rate policy has rewarded investors at the expense of savers.

Folks who have invested in stocks and bonds have made out like Bonnie and Clyde. But those who have put their hard-earned savings into money markets, CDs, and Treasury bills have precious little to show for it.

Unfortunately, this latter group includes a lot of retirees of a conservative bent. If you’re one of them, however, I have good news, a way that you can make your retirement income last forever. (By “forever” I mean as long as you and your spouse are drawing breath, which is your own personal forever.)

Moreover, it’s an especially good deal if you’re in reasonably good health. I’m talking about immediate fixed annuities.

If you’re a longtime reader of mine, you just might be requesting CPR right now. I’m the guy who has made a fetish of explaining how annuities are a lousy deal for just about everyone but the annuity salesman and his employer.

I stand by that. But this is an exception.

Understand that there are more varieties of annuities and insurance products out there than animals in the San Diego Zoo. Variable annuities, in particular, are to investors what quicksand is to hikers. Once you fall for the sales pitch, you’re generally stuck.

However, the sheer mind-bending variety of variable annuities is what allows every insurance salesman to chirp, “But this annuity is different.” Indeed it generally is – and in ways you may soon regret.

In my experience, insurance salesmen generally neglect to disclose a few key facts about variable annuities:

• These are among the highest-commission products in the entire financial industry with the highest annual fees.

• Your annuity is not FDIC-insured.

• Withdrawals prior to age 59 1/2 are subject to an IRS penalty.

• Variable annuities carry a surrender penalty of up to 10%.

• Your eventual gains – if you have any – will be hammered at your income tax rate, not the lower capital gains tax rate.

Given what I just said, why would I recommend immediate fixed annuities? Because they are different.

In particular, they can be the key to squeezing the maximum income out of your retirement savings. And – as you’ll see – you now have a great way to evaluate them.

Here’s how an immediate fixed annuity works. You hand over a lump sum to an insurer… It then pays you a fixed income every month for the rest of your life.

In the financial realm, things don’t get much more straightforward than this.

According to New York Life Insurance, if you put $100,000 in an annuity today at age 65, you will receive $6,269 a year if you’re a man, $6,007 if you’re a woman, and $5,138 if you’re a couple who want income paid until the second spouse dies. (For obvious reasons, the payout is greater if you’re older and less if you’re younger.)

A quick calculation reveals that even the lowest payout above amounts to a guaranteed annual return of 5.13% to you and your spouse for the rest of your lives.

How is this possible when bond yields aren’t nearly this high? Because neither you nor your heirs will ever see the principal again. If you die early, the insurance company wins. If you live a long time, you win.

I should mention that, according to the Centers for Disease Control and Prevention, American longevity is increasing by three months a year. Many retirees will spend up to three full decades in retirement.

Immediate fixed annuities can be a particularly smart choice for people who are nonsmokers, moderate drinkers (or teetotalers), not obese, and in reasonably good health.

However, you should not buy an immediate fixed annuity through an annuity salesman or even directly from an insurance company. Instead you should visit the 900-pound gorilla of personal finance: The Vanguard Group, the only mutual fund group that is owned by its fund shareholders.

Vanguard does not offer annuities itself. But it uses a platform called Hueler Income Solutions to broker immediate fixed annuities at the lowest possible cost. All of the insurance companies it uses are A-rated or above by A.M. Best, Moody’s, or Standard & Poor’s.

In the insurance industry, transaction fees – which are generally hidden – for immediate fixed annuities are 4% to 6%. Vanguard’s fee is 2%. As an investor, you don’t pay this fee directly but – as with all insurance products – it will affect your return. In this case, the lower the fee, the higher the return.
If you called up Principal Financial Group, Mutual of Omaha, American General, or National Integrity directly, you would not be entitled to this lower cost. (And let’s remember that investors are generally dealing with a large chunk of money here.)

To get a real-time quote that can be locked in for 30 days, Vanguard will need your date of birth and your current home state. But here’s the important part. Vanguard isn’t interested in selling you an annuity. The agents do not work on a commission basis. They will ask you about your personal circumstances, your investment and income goals, and your level of knowledge about how immediate fixed annuities work.

But – here’s the crucial difference – they may conclude that an annuity is not suitable in your case. Trust me, this rarely (never) happens in a conversation with a commissioned annuity salesman. To speak with an annuity specialist at Vanguard, call 800-357-4720.

Here’s a final tip. Any insurance guarantee is only as strong as the company that makes it. If you’re investing a substantial sum, it makes sense to spread it around among top insurers.

(Yes, there are state industry-backed guaranty associations acting as a backstop, but they have limits. In a major crisis, they may not cover your insurer’s insolvency. To find your state’s limit, visit www.nolhga.com.)

Immediate fixed annuities are a one-decision investment. If you decide to plunk for one, the only thing left for you to do is maintain the healthiest possible lifestyle.

Or, as Mr. Spock would say, live long and prosper.

Good investing,

Alexander Green, Chief Investment Strategist, The Oxford Club for Bonner & Partners 

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters. © EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle

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