It is one of the toughest decisions you face on the road toward retirement or in retirement. Once made, the decision can’t be changed. Your choice can alter your retirement income by 10% or more – every month for the rest of your life.
I’m talking about the choice of how to take regular payments from your employer’s retirement plan or from an insurance annuity. (To keep things simple, I’ll only talk about employer retirement plans, but many of the same principles apply to insurance annuities.)
In most traditional employer plans, you have the option of taking regular monthly payments for the rest of your life. Payments usually can be taken over only your life (single life annuity), over a period of years (fixed term), or over the joint life of you and a beneficiary (joint and survivor). There usually are several joint and survivor options. After your death, the survivor can receive the same payment as while you were alive (joint and 100% survivor), or something less.
Typically, an employee who wants regular income looks at the monthly payment options and chooses one. But reviewing the options offered by your employer should be only the beginning of the decision process. You aren’t limited to those options in most cases and might be able to do better.
Most employer plans also offer a lump sum option. If your plan does, ask what lump sum benefit you can receive instead of monthly payments. This is where things get interesting, and profitable.
Once you know the lump sum amount, begin shopping for an annuity. There are several sites on the World Wide Web that offer annuity quotes from a number of insurance companies, and there also are firms that offer the same service through toll-free telephone calls. Many are listed in the box. You also can check with local insurance agents.
You’ll find that the monthly income you can receive from your lump sum will vary considerably. The highest and lowest payments can vary by as much as 25%, even among insurers with top safety ratings. There are differences because annuity payments are based on long-term assumptions about life expectancy and the future investment earnings of the insurance company. An insurer that assumes a lower life expectancy can afford to pay you more each month. Likewise, an insurer that assumes higher interest rates or investment returns in the future will make higher monthly payments.
Suppose you would get a lump sum of $200,000 and are a 65-year-old man. According to the Annuity & Life Insurance Shopper that amount could purchase monthly payments ranging from $1,412 to $1,694. That is a $282 difference every month for the rest of your life. That’s worth spending some time shopping around.
But don’t stop there.
The big advantage of an annuity is that you receive the same income each month for the rest of your life. There is no risk of outliving your assets. A disadvantage is that the monthly income is fixed. Inflation will reduce the purchasing power each year. Another disadvantage of an annuity is that there is nothing left for your heirs. You won’t outlive the money, but the money won’t outlive you and your beneficiary either.
One option, which clearly would have produced the best results over the last 15 years, is to forget the monthly payments and invest the lump sum yourself through an IRA rollover. The lump sum could be invested in a mix of stock and bond funds according to the risk you are willing to take, or put in a balanced fund. The investments will pay some income, and you sell shares to take any additional income you need. As long as your total return over time exceeds the interest rate that was assumed by the annuity (and you don’t spend all the excess return), you’ll end up better off than with an annuity. By investing yourself, you also have the option of taking more money from time to time if you need it and taking less when you don’t need it.
With one of these do-it-yourself-annuities the big risks are that the investments fall sharply soon after you take the lump sum or that the long-term returns are less than expected. In either scenario, you face the risk of outliving your assets.
A third option is to combine the two strategies. Shop around for the best annuity you can find, and buy that with a portion of your lump sum. That gives you a guaranteed minimum income for life. Then invest the rest of the lump sum through an IRA rollover.
When considering how to get regular income from a pension plan or annuity, you have a wide range of options and could dramatically increase retirement income by carefully analyzing and choosing from among those options. You should meet with an accountant or financial planner to make sure you analyze all the angles. But don’t automatically take the simple options offered by your employer or insurance company.
Finding Annuity Quotes
Annuity & Life Insurance Shopper 800-872-6684 (Heritage Chase-Talmadge Chase #8, Monroe Township, NJ 08831-9999)
InsuranceQuote (800-972-1104) – free quotes with no obligation to buy.
SelectQuote (800-343-1985) – free quotes with no obligation to buy.
Quotesmith (800-556-9393) – $15 for a list of quotes.
USAA (800-531-8000) – direct seller of its own low load policies.