401(K) BECOMES A 201(K). NOW WHAT?

Warren Buffet has been quoted as saying, “My 2 top rules for investing are, #1- Never Lose and #2- Never forget rule #1.” Retirees who watched in horror as their account balances plunged along with the stock market in 2008-2009 had to face a bitter challenge: how to generate enough income to pay their bills for the rest of their lives with the assets, the money they had left. Retirement in all about income.

The tired, stale but widely accepted rule of thumb retirees they could take 4% of their assets per year and increase the amount for inflation by 3% each year and their money would last 30 years. Not! In some cases, you could be 50% or more off.

ikThen they suggest, depending on the extent of your losses, you may want to freeze your withdrawals at current levels, skipping the annual inflation adjustment until the market rebounds. Or, if you suffered significant losses of 30% or more, you may want to restart your 4% withdrawal schedule based on the new, lower balance. But that can take a big bite out of your income. Say you started with a $1-million retirement stash and had been withdrawing more than $40,000 a year. If your savings shriveled to $700,000, you’d now have to get by on just $28,000 a year. This is a ticking time bomb that will blow up.

There is, however, another way to stretch your income and increase your annual withdrawals to 8% or more of your savings. And you can still be assured you won’t outlive your money. A study by the University of Pennsylvania’s Wharton Financial Institutions Center found that you could create a stream of secure lifetime income for 25% to 40% by using an immediate annuity. What I don’t like though is with an immediate annuity, you give up control of the money. And although you get the maximum monthly income with a single-life annuity, it stops paying out when you die. If you die prematurely, you forfeit a chunk of your initial investment (which is then returned to the investment pool to pay the benefits of other annuity holders). Therefore, a Fixed Indexed Annuity is likely better for most retirees. You do not give up your money, or the future growth and you still can provide a guaranteed lifetime steam of income.

lklHow much to invest in an annuity strategy for income can best be determined by working backwards to figure out the appropriate amount to allocate to an annuity strategy.  First, add up your regular expenses and then subtract any guaranteed income you already receive, such as a pension and Social Security benefits. If there’s a gap, consider filling it with an annuity. Getting lifetime income illustrations to review from a non-biased retirement income planner can be very helpful to determine how much future guaranteed income you will need. Remember, once retired you do not have time to wait for the market to get your money back. You are likely to need some before that.

I look at only companies that are B+ or higher. For an extra layer of protection, it can be an added measure of security to diversify among companies, none to exceed the $250,000 limit covered by California’s guaranty association, which protects investors if an insurer becomes insolvent. (Some states have higher protection limits; see http://www.nolhga.com for links to each state.)

Securing a guaranteed stream of income for the rest of your life may bring peace of mind, but it does not guarantee that you will maintain your future buying power unless properly planned and possibly laddered in some form. Getting the extra money when you’re older is much more important than having the extra cash early in retirement. To me, it fits with the logic of annuities — that you’re worried about living a long time and running through the rest of your savings. An annuity is an insurance contract, and it should be about future guarantees and certainty.

Although most retirees like the idea of guaranteed income, many balk at the idea of giving up control of their money with an immediate annuity. As a result, an increasing number of retirees have been turning to another type of insurance product, called a Fixed Index Annuity, that allows you to earn money based on the increase of a market index but never lose as a result of a declining market. They provide much more flexibility in addition to the income certainty they provide. They also provide guaranteed compounding for income even if the market goes down.

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