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One of the biggest risks in retirement is outliving your savings. You can save carefully through the years, but there's a big unknown when you start to withdraw the money: You don't know how long your savings need to last because you don't know how long you'll live.
An income annuity can guarantee that you'll receive a check every month for the rest of your life. It can help supplement other sources of guaranteed income, such as Social Security, and can be especially valuable if you don't have a pension. Annuities also help to protect you against stock market turmoil. Your payouts will continue no matter what happens in the stock market or how long you live.
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Most experts recommend that you have enough guaranteed income to cover your necessary expenses such as housing, transportation, food, etc. If that amount comes to more than your Social Security benefits and any money that you might receive from a traditional pension, buying an annuity that covers the difference can be a good idea. However, you'll also need savings for emergencies, other unexpected expenses and life's pleasures. Those costs can be covered by the rest of your savings. If you follow this strategy, an immediate annuity that starts paying lifetime income right away could be a solution.
However, immediate annuities can be complex and expensive. The cost of the guaranteed income can seem high. For example, if a 65-year-old man invested $100,000 in an immediate annuity, he could receive $494 per month ($5,928 per year) for life. Monthly payouts are lower for women because they have a longer life expectancy — a 65-year-old woman could receive $469 per month. (Note: All of the estimated income in this article reflect the cost at the time of its writing and are illustrations only.) The amount of income you'll get from an immediate annuity will vary depending on economic conditions at the time you make a purchase, which payout options the annuity has and which company issued the policy. It pays to shop around for the best payout. Annuities can also be inflexible, and the decision to buy an immediate annuity is generally irrevocable. If the individual in the example's circumstances changed, he couldn't change his mind and get his money back after he invested in the income annuity.
An alternative to buying an immediate annuity is to depend on a combination of Social Security, pension benefits (if you have them) and your savings for retirement income. But this is where longevity risk comes in. If you depend on your savings to supplement Social Security, you're much more likely to run out of money in your 80s than you are in your 60s.
Another type of income annuity can help reduce this risk. It's easier to calculate how much you can afford to spend in the early years of retirement when you know you'll receive lifetime income later on. A deferred-income annuity, also called longevity insurance, provides lifetime income starting several years in the future, such as in your 70s or 80s. You can decide when the income starts when you buy the policy, but, in general, the farther into the future the payments start, the more you will get each month. For example, a 65-year-old man who invests $100,000 in a deferred-income annuity could receive $1,673 per month starting at age 80 ($20,076 per year), says Ariel Stern, chief operating officer of ImmediateAnnuities.com. Payouts are lower for women because they tend to live longer — a 65-year-old woman would get about $1,466 per month ($17,592 per year).
Many academics like longevity insurance because it's an efficient way to provide the highest guaranteed income payouts for the people who live the longest. The monthly payouts for deferred-income annuities are much higher than they are for immediate annuities, and you'll come out further ahead the longer you live beyond average life expectancy. In addition to eliminating the fear of running out of money, a deferred-income annuity also gives a firm time limit on how long you'll need to depend on your savings. If you retired at 65 and have a joint-life annuity that starts to pay at age 80, you know that you'll need to make your savings last only 15 years, regardless of how long you or your spouse live.