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Annuitizing your savings

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Reducing risk
Retirement today is filled with risks that personal savings alone can't address. The biggie is longevity. The longer you live (and chances are you'll probably live longer than your ancestors), the more money you'll need and the greater your chances of running out. While average life expectancy is 77 years, according to the Centers for Disease Control and Prevention, those who reach age 65 can expect to live another 18 years to age 83. In fact, the over-85 set is the fastest-growing segment of the population.

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Another biggie is inflation risk, or not being able to keep up with ever-rising prices. Finally, there is investment risk, the possibility that a market downturn will hit your portfolio just when you need the money most.

"These risks were largely managed by defined benefit (pension) and Social Security programs," says Peng Chen, president of Ibbotson Associates in Chicago. "Now they need to be managed by individual investors."

Annuitization can take the sting out of all three risks. First, there's no fear of running out of money, since by its very nature annuitization provides lifetime income. Second, you can invest your other assets in higher-risk fare that has a better chance of beating inflation. And third, if a bear market strikes, you can ride out the storm.

"If you don't have to touch the stocks in your portfolio, there's your investment hedge," says Rande Spiegelman, vice president of financial planning with the Schwab Center for Investment Research in San Francisco.

Milevsky and Chen earned a patent in 2006 showing that the right combination of annuitized and nonannuitized assets in retirement can significantly reduce a person's chances of running out of money. For example, with a portfolio composed of 60 percent stocks and 40 percent bonds where an investor takes systematic withdrawals to meet his or her income needs, the pair found that the chances of depleting assets starts to rise before age 80 and runs to about 49 percent at 100. But annuitizing about half of such a portfolio greatly enhances the chances of not running out of money.

How to annuitize assets
Workers who are lucky enough to have a pension are usually better off opting for a lifetime annuity payout rather than a lump sum if presented with the choice. It might be tempting to get one big pot of money all at once, but most of us are pretty lousy at managing that kind of money and making it last.

"You're not only managing the withdrawal, but you also need to manage the lump sum to insure that you won't erode the assets at a rate greater than inflation," says Jean Setzfand, director of financial security at AARP in Washington.

Some employers offer an annuity feature to workers in their 401(k) and 403(b) retirement accounts when it's time to withdraw the assets. With these plans, savers can opt to receive their accumulated assets or a portion of their assets as a lifetime annuity. Larger corporations are more apt to offer this feature.

 
 
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