We all love guarantees. And when it comes to retirement, we especially like the idea of guaranteed lifetime income. After all, no one wants to run out of money before they run out of life.
There are only a few sources of guaranteed lifetime income. Social Security is one, though the benefit amount and timing do get tinkered with occasionally. Insurance companies offer the other source of guaranteed income through income annuities.
With Social Security, the federal government effectively stands behind the guarantee. With insurance companies, the individual company stands behind the guarantee, along with perhaps a state-led agreement that all the insurance companies in a state offer to bail out any one company in trouble.
Unfortunately, if you find yourself in retirement owning an annuity from an insurer that’s in trouble, your payments may be delayed. Even in some instances, those payments have been reduced. How can you avoid that situation happening to you?
As in most money matters, diversify. Rather than put all your retirement eggs in one basket—one annuity—spread your annuity purchases out over several companies. Yes, you’ll have more applications to fill out and more statements in the mail, but you’ll also have more peace mind knowing that your “guaranteed” lifetime income comes from several guaranteed sources.
What if you already own just one annuity; can you still diversify? Yes, by completing what’s known as a “1035 exchange.” Your insurance agent/broker will know how to handle it. It works just about like an IRA rollover, so you’ll continue to enjoy tax deferral for your annuity money.
If you do want to switch money from an existing annuity to one with a new insurance company, be sure to watch out for surrender charges. These charges are designed to keep the money in your current annuity, and usually amount to a percentage of the assets you’ve invested. Surrender charges often decline over time, so it may be worth waiting a year or two before you move money to a new annuity company.
If you receive a pension from your company’s retirement plan, odds are your former employer purchased an annuity for you. In this case, you probably do have just one egg in one basket. Unfortunately, there’s probably not a lot you can do about it, though it won’t hurt to ask. Ideally an employer will purchase a few annuities from different insurers to generate your pension payment, but that rarely happens.
If you’re about to retire in 2012 and you have a pension plan, you might want to consider taking a single, big distribution (lump-sum) rather than an annuity from your employer. Why? Interest rates are very low today, and the amount of your pension payment may be affected by today’s lower interest rates. What you might do instead is take your entire pension benefit in one fell swoop and roll it to an IRA (to keep from having to pay taxes on the entire amount at once). Then use a portion of it this year to buy an income annuity, wait a year and buy another income annuity, etc.
That way you’ll be buying several smaller annuities with different interest rates. If rates rise in the future, your annuity payment will increase also. And if for no other reason, when you buy a new income annuity, your new annuity payment will increase each year because you are older. Even if interest rates fall in the future, your new annuity purchases will usually generate somewhat larger payments because you are older.
The other advantage of taking a lump-sum distribution from your employer’s pension plan is control. You control how much you spend on these small annuity purchases, and the remaining money is not locked up. If a big expense comes along in retirement (maybe a major medical expense), you’d have the money on hand to pay for it. As the years go by, maybe your spouse passes away and you don’t need so much income; in that case, you just keep the remainder of your lump-sum in your IRA and stop making the smaller annuity purchases. You can then keep the IRA money to use as you wish, maybe to pass on as an inheritance.