We know that we ought to insure ourselves against the risk of dying too soon. But something new is happening, thanks to healthy living and good medicine. We have to think about insuring against the risk of living too long.
You're pretty safe, financially, if you have a company pension and can live on that income plus your Social Security check. Both cover you for life. Social Security rises with the inflation rate, so it never loses purchasing power. Some pensions, especially public pensions, have inflation adjustments, too.
But around 53 percent of the work force isn't in a pension plan, according to the Employee Benefit Research Institute. Instead, they have some form of personal savings -- say, 401(k) or 403(b) plans, inheritances or savings outside a retirement plan.
If you retire at 60, you might live for another 30 or 40 years. How can you be sure that your savings will last as long as you do?
That's a job for immediate-pay annuities. An insurance company takes your lump-sum savings and turns it into an income for life. You can also cover the joint lifetimes of you and your spouse.
A fixed immediate annuity gives you a guaranteed sum each month. Fixed payments make it easy to budget, but inflation will nibble away at your purchasing power.
A variable immediate annuity links your income to the future performance of stocks and bonds. In some years, your income will decline. But over time, it stands a good chance of rising -- perhaps substantially.
Variable payments are generally lower than fixed payments at the start. But they could rise much higher over the years.
Any immediate annuity should be guaranteed for life, not just for a late age like 100, says Glenn Daily, a fee-only life insurance planner in New York City (fee-only planners don't take sales commissions). You'll be interested in immediate annuities if:
You have no monthly pension. You might want to turn part or all of your IRA or 401(k) into a lifetime income.
You want an income that could keep ahead of inflation. The newest variable immediate-pay annuities -- from Minnesota Life in St. Paul and T. Rowe Price in Baltimore -- limit how far your income is allowed to fall. In a terrible stock market, your check could never decline by more than 15 percent or 20 percent, respectively.
You know zero about investing, and don't want to make a huge mistake with the only money you're ever going to have.
You have a cash-value insurance policy that you don't need any more. You could roll the cash value into an immediate-pay annuity, which also stretches out any taxes due.
Fixed immediate annuities can be bought later in life -- say, early 80s for a woman, late 70s for a man, says Moshe Arye Milevsky, an assistant professor of finance at York University in Toronto.
Until then, you might create a home-baked annuity, Milevsky says. Put 60 percent or more of your money into diversified stock-owning funds, then withdraw the very same monthly amount the insurance annuity would have paid. At a later age, buy the lifetime insurance annuity with the money you have left.
Variable immediate annuities, however, should be bought at retirement. You need to allow enough time for a stock strategy to work.
A final tip on variables: The insurer assumes that the value of the investments in your annuity will rise by a modest annual rate -- usually between 3 percent and 6 percent. You receive an increase in payments only if the market rises by more than that amount. If it rises less, your payment will decline.