If you get into a car accident, you have car insurance to pay for it. If you get sick, there’s health insurance. You can even use disability income insurance to insure your paycheck against the possibility that a disability prevents you from working. But when you get to retirement, it will be up to you to use your savings to create income — and what if something goes wrong?
There are any number of risks that can throw a wrench into reliably generating income from your savings for 20 to 30 years (or more): your lifespan, market crashes, inflation, taxes and the cost of health care, to name several. How do you help ensure that these risks won’t derail your retirement?
Ultimately, a solid financial plan that takes these risks into consideration can provide some level of retirement “insurance.” However, there is also an insurance product that helps protect your ability to maintain reliable income in retirement.
We’ll get to how a solid financial plan can help you cover retirement risks in a bit, but let’s start with the actual insurance that you can get for your retirement income.
CAN I GET INSURANCE FOR RETIREMENT INCOME?
The insurance product built to help protect retirement income is known as an income annuity. An income annuity makes regular payments to you for the rest of your life. The payments aren’t affected by the ups and downs of the market, and the regular payments continue as long you live (you can also base it on two lives — typically you and your spouse).
With an income annuity, you make either a lump sum premium or a series of contributions and in return the insurance company guarantees regular payments to you, so it takes on the risk of managing the money that you contribute to an annuity in order to fulfill that guarantee. In addition, the annuity is insurance against the risk that you may live longer than expected — you’ll never outlive your payments.
HOW DO INCOME ANNUITIES WORK?
Income annuities come in two main varieties: deferred and immediate. With a deferred income annuity, you make a payment today for income that will start sometime in the future, usually a year to a decade or more from the time of your payment. With an immediate income annuity, payments start right away, usually a month to 12 months after your initial payment.
Once you put money into an income annuity, aside from your regularly scheduled payments, you can’t simply withdraw your money; the premium is non-refundable and the annuity can’t be surrendered. That causes many people to worry that their beneficiaries won’t get their money back if they (the annuitant) die earlier than expected. However, there are many ways to structure an annuity, including a feature that guarantees your payments will last for a certain amount of time. If you die prior to that time, a beneficiary (perhaps your children) will get the remainder of the guaranteed payments for the stated period of time. In addition, some annuities have an optional death benefit to make sure your loved ones get back at least the money that you contribute to an annuity, minus any income payments already paid out.
WHAT ABOUT THE OTHER RISKS TO MY RETIREMENT INCOME?
Some income annuities not only provide guaranteed payments you can’t outlive, but also offer potential for payments to increase, providing a hedge against inflation. They play a role in helping shield against the other risks, as well. But a solid retirement income plan will typically use a mix of strategies, including keeping a cash reserve, investments for growth, insurance for other risks like the possibility of a long-term care event, and more. A financial advisor can help you put together a plan for generating retirement income in a way that accounts for risks both before and in retirement.
Income annuities have no cash value. Once issued, this annuity cannot be terminated (surrendered), and the premium paid for the annuity is not refundable and cannot be withdrawn.
Distributions taken from income annuities may be subject to ordinary income tax. A 10 percent federal tax penalty may apply if you take any type of distribution from the contract before age 59½.
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