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Annuitizing your savings

There comes a point in every saver's life when it's time to stop saving and start spending. There are lots of calculators to help you figure out how much regular income you'll need once you stop working. But where will this money come from?

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The traditional sources of retirement income, often referred to as the three-legged stool, belong to a bygone era of Nehru jackets and Rubik's Cubes. These three income sources -- company pensions, Social Security and individual savings -- worked together to create retirement security. There was little risk of running out of money -- if these three sources contributed their fair shares.

"Thirty to 40 years ago most companies offered defined-benefit pension plans," says Moshe Milevsky, associate professor of finance at York University in Toronto. "Nowadays that's not the case. And more of us are living to a ripe old age, so we have to create longevity insurance for ourselves."

While longevity is certainly a wonderful thing, when it comes to retirement planning, it's a wild card. Without knowing how long you live, it's nearly impossible to fashion a systematic program of income distribution that keeps flowing till your very last day.

Defined-benefit pensions are a guaranteed source of income, an assurance that no matter how long you live you will continue to collect a check. The same is true of Social Security, which provides inflation-adjusted payments for life. Current retirees receive some 69 percent of their incomes from these two sources, according to the Employee Benefit Retirement Institute. But today's workers can expect these two sources to account for just a third of their income needs.

That leaves individual savings to assume a bigger role. The only problem is, "You can outlive your personal savings," says Bill Reichenstein, professor of finance at Baylor University in Waco, Texas.

Milevsky, Reichenstein and others say that future retirees should strongly consider annuitization, a process of converting some savings into predictable income. There are several ways to achieve this, but the goal is to secure a steady check month after month.

"That gives you a floor of income you can't outlive. You at least get that," Milevsky says.

A measure of satisfaction
It might also make you happier. According to Constantijn W. A. Panis, manager with Deloitte Financial Advisory Services in Los Angeles, having an income stream that funds at least 25 percent of your retirement spending boosts retirement satisfaction to almost 70 percent.

"People who derived much of their retirement resources from an annuity exhibited fewer depression symptoms," says Panis about his 2004 study of defined-benefit pensions. "At any given level of income, just having a portion of retirement resources in the form of annuities was perceived as having more money."

The opposite is also true. The longer people were in retirement without annuitized income, the more their satisfaction declined, he found. Though Panis looked specifically at defined-benefit pensions, he believes his results can be applied to other types of guaranteed lifetime income except Social Security.

Next: The longer you live the more money you'll need.
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