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.
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.