The biggest financial fear for those planning for retirement and, particularly for those who are already retired, is losing all your sources of income. Of course, Social Security will always provide you with an income, but for most it won't provide much more than the basic necessities. All the better if you're fortunate enough to be receiving a pension. But the percentage of retirees who are receiving a pension is dwindling.
So for the majority of those planning for retirement or who are already retired, there are two sources of retirement income: Social Security and your own retirement savings. Here are my musings on both:
- Social Security. While you may think you have no control over Social Security, you do to the extent that you carefully evaluate the best time to begin collecting benefits. Delaying the collection of benefits as the potential of increasing your Social Security income by over 50 percent. If other sources of income fail to keep up with inflation or, worse, fall by the wayside, a higher Social Security income will offer a measure of protection.
- Your retirement savings. Unless you'll receive a pension, your retirement savings will probably generate most of your retirement income. Therein lies the concern over running out of money, which can happen for any or a combination of several reasons, including:
- Outliving your money. You may simply live a lot longer than you had planned for financially.
- Withdrawing too much. Getting into the habit of withdrawing too much money is a ticking time bomb for many retirees.
- Investment losses. Whether through bad investment decisions – yours or those of an investment advisor - and/or bad investment markets, a nest egg can evaporate a lot sooner than anticipated.
- Major expenses. In addition to the most feared major expenses of requiring home health care or a nursing home, other unplanned expenses, like the need to help support a child through a rough patch or major home improvements can quickly erode, if not decimate, retirement savings.
Deciding where to put your retirement money. Deciding how to deploy a lifetime of hard-earned savings deserves very careful deliberation. In effect, should you invest the money either on your own or with the assistance of an investment advisor, or should you take out an income annuity (also called an "immediate annuity")? While there are several flavors of income annuities, all involve depositing money with an insurance company in exchange for a guaranteed income, usually for the rest of your life. This is a particularly important decision because the annuity decision is for all intents and purposes one you cannot change later on. Once you select an annuity, it will be with you for a lifetime.
Key considerations. Here in a nutshell are the key considerations when making this key decision:
- Investment risk. Managing the money on your own is a big responsibility. If you lose it in the unwise investments -- or even "wise" ones that go sour anyway -- there's no recourse but to suffer in silence. If you're confident of your own investment abilities -- or those of a competent advisor -- you may be better off managing the money on your own. On the other hand, if you've got more interesting things to do after you retire than worry about your investments, then why not foist that burden on the annuity company.
- Liability risk. Money that you manage on your own is usually not protected from liability. The principal may have to be used to pay major medical (or other) expenses, including nursing home costs, if the income from those investments is insufficient. This is of particular concern to couples, since the illness of one could leave the surviving spouse or partner with little to live on. Also, you can be sued for just about anything these days, and all or much of your nest egg could be lost to legal and settlement costs. While income from the annuity will need to be used to pay medical or lawsuit expenses, the annuity itself should not be subject to forfeiture.
- Inflation risk. While you can purchase an annuity whose payments are adjusted (at least partly) to offset the effects of inflation, many are not. The reality of a fixed payout annuity is a steady loss of purchasing power due to rising living costs. On the other hand, if you self manage your money, you have a good, but by no means assured, chance of investing it so that it gains enough to enable you to keep up with inflation.
- Anticipated income. Generally, annuity payments give you less income than you can make if you invest the money on your own. Reason: the payout schedules tend to be figured very conservatively to minimize the annuity company's future financial risks. On the other hand, the annuity business is very competitive, so shopping for the best deal (so long as it is offered by a financially strong insurance company) will narrow the gap between what the insurance company pays you and what you might be able to earn on your own.
- Longevity risk. The main advantage of an annuity, and it's a big one, is that the insurance company is stuck with making its payments to you as long as you live. If you're married or partnered and you wisely select an annuity that will pay both of you for life, you'll also protect against any financial misfortune that may befall a surviving spouse or partner with respect to self managed money.
- Mortality risk. While a few annuity plan options provide benefits after death, most annuity plan payments cease when you do. Consequently, when you die there's nothing to pass on to your heirs. If you manage your retirement money on your own, and the investment gods are with you, you have a good chance of being able to leave some left over money to your heirs.
Not an "either/or" decision. Before concluding that there is no way you can make the right decision, here are my two cents worth of advice. Don't view the "self manage" versus "annuity" choice as an "either/or" decision. It isn't, and anyone who suggests otherwise is more interested in getting a fat commission than looking out for your best interests. Purchasing an annuity is often a wise decision, particularly if any of the above noted downsides of managing your money yourself is particularly angst provoking. If you decide to take out an annuity, you should rarely annuitize all of your money, nor should you annuitize all of the money you want to annuitize at the same time. Instead, you might be better-advised to invest half of the total money you eventually want to put into an income annuity when you retire and wait several years to invest the other half.