Below is an excerpt from the book Downsize Sooner than Later – 18 Rules for Retirement Success available on Amazon.com.
The question of when a person should switch on a lifetime income stream – or annuitize – is an ongoing debate topic for economists.
The best answer I have heard given so far is to do so “when it no longer makes sense not to.”
For example, delaying the commencement of lifetime income from Social Security from age 68 to 70 is helpful for many people because it leads to a significant increase in lifetime inflation adjusted benefits. But once age 70 is reached, even if you could delay further under current rules, it would not “make sense” to do so.
For certain union, public sector, and company-sponsored pension plans, the specifics of the retirement plan itself are the controlling factors on the question of when to annuitize.
A few examples:
• Once qualifications are met, some plans may allow full lifetime benefits to begin at early ages – even as low as in one’s 50s.
• Other plans offer enhanced benefits for delaying the start of lifetime income payments until certain future ages.
• Yet other plans impose “caps” such that delaying or working beyond past certain thresholds has no appreciable benefit.
If you are in a union, public sector, or company-sponsored pension plan, consult with your plan administrator to discover the best options for your individual situation.
When it comes to insurance company annuities, answering the question of when to annuitize optimally is less clear. For such annuities, in general, the longer a person waits to annuitize, they gain the opportunity to achieve two potential benefits:
1. Core nest egg funds have more time to compound and grow – at least theoretically.
2. Income from lifetime annuities generally becomes less costly to initiate at older ages.
Delaying annuitization presumes you have the resources – such as additional income from continuing to work full or part time, income from other sources, or other available funds – to wait without damaging or impairing your ability to initiate annuitization in the future.
As relates to gaining the opportunity for additional compounding through delay, there is always the risk that markets experience a downturn while you are waiting.
If investments are a part of the story – such as in the portfolio-based retirement model – such risk will be a factor. A defense against market turbulence that would enable you to delay annuitization and yet make sure you have the funds needed to turn on a lifetime income in the future would be to fund a fixed “deferred annuity” when nearing, beginning, or sometime early within your retirement years. Deferred annuities come in a variety of forms but are essentially annuity contracts in which the income stream has not yet been initiated and can be voluntarily turned on later.
- Deferred annuities allow you to sequester the funds required to establish guaranteed income in the future, while simultaneously offering a buffer from ongoing market risk.
- Deferred annuities grow tax deferred and can be surrendered for their cash value in the future, if the income stream has not been initiated. Taxes will be due on any untaxed gains and, if surrendered too early, sales and administration charges may be deducted.
- Certain “hybrid” deferred annuities offer riders to provide long-term care expense protection.
Purchasing and holding deferred annuities inside qualified retirement plans such as IRAs has significant limitations, due to the potential impact they pose on required minimum distributions. To partially resolve this issue – and because the government recognized the need for greater access to lifetime income options late in life – entities known as QLACs or “Qualified Longevity Annuity Contracts” were established in 2014. If a QLAC is properly structured within IRS guidelines, it can be exempt from RMD rules before income payouts begin.
The fact that income becomes cheaper to acquire at older ages is, on its face, a plus.
The older you get, the less time you statistically have left to live. Because of this, insurance companies can afford to offer higher payouts per dollar of premium paid to older individuals. However, interest rates can play a role in reducing this potential benefit, should they decline during delay.
For retirees in above-average health, the most important factor in relation to the question of delaying or beginning annuitization is the risk of depleting core nest egg assets before they are needed to fund a future income stream. Some people simply wait too long and end up consuming the very funds that may otherwise have been capable of rescuing them. In so doing, they deplete their core funds and are left with no recourse.
As a general rule, I am not a proponent of lifetime annuitization through voluntary insurance company annuities before age 70.
But that’s just my opinion. My outlook is based on the higher upfront cost – i.e. the higher amount of premium required to purchase immediate lifetime income annuities under the age of 70 – and for reasons that relate to the benefits of delaying Social Security.
Imagine you are a healthy person who would like to retire at age 60. Would it make sense for you to initiate a lifetime income stream from such a young age? If not, then when might it make sense to do so? How can you decide? How do you know from the outset that you even have enough funds to make the decision to retire?
A clarifying question that can help resolve this dilemma is to ask, “Do you have the financial resources to retire at age 60 while simultaneously continuing to delay your Social Security to age 70?”
To answer in the affirmative, you must be able to retire and pay necessary bills until age 70 without depleting your ability to sustain yourself after age 70. When age 70 arrives and Social Security benefits are switched on, there must be adequate funds remaining to:
- Secure any additional lifetime income needed to cover ongoing bills.
- Establish (or continue) a long-term growth fund.
- Provide enough liquid funds for emergencies.
If all these conditions are met, retiring now and waiting to annuitize until after age 70 (or later) seems feasible. It is possible that some choosing to retire early may wish to secure a fixed-period annuity to “bridge” the gap between their earlier retirement age and age 70. For example, at age 60, a 10-year period certain annuity would be purchased to guarantee income needs for the 10 years prior to age 70. At age 70, when the period certain annuity depletes, Social Security benefits begin. This opens the door to safely retiring early while simultaneously delaying Social Security to maximize future benefits. Many individuals wishing to retire in their mid-to-late-60s may benefit substantially from such an approach.
For those lacking the desire or the wherewithal to retire early, choosing to adopt a pooled income strategy will generally mean initiating a supplemental income stream somewhere between the ages of 70 and 89. As mentioned earlier, the danger during these ages is the risk of waiting too long and depleting or losing funds necessary to secure an income in the future.
Other questions to help shed light on when to annuitize:
- Will you work part-time in retirement (i.e. post age 70) and be able to pay bills in conjunction with your Social Security benefits and RMDs without the risk of overconsuming your nest egg funds?
- Will you have other renewable income sources you can rely on – such as income from rental property or business income – that will hold you over until later?
- Will you be able to pay your ongoing bills with current combined levels of pooled income from Social Security, pension income, or other life annuities?
If the answer to any of the above questions is “yes,” then it may be fine to wait. But if you are in a portfolio-based income plan and are rapidly consuming your core nest egg funds to make ends meet, you may wish to consider breaking out a portion of those funds sooner to lock in a lifetime income stream.
Here are a few hypothetical scenarios that may also help answer the question of when to annuitize.
Jake accumulated $400,000 in a 401(k) that he rolled over into an IRA upon retirement at age 70. He also has $150,000 in non-IRA funds invested separately in broad-market index funds. The non-IRA money came from the combination of a small inheritance and downsizing his home. Jake delayed Social Security to age 70, but also kept working in a part-time job that he enjoys. Between his Social Security, part-time income, and the required minimum distributions (RMDs) from his IRA, Jake had enough income to cover all his expenses, pay for fun things to do with his wife and family, and continue to contribute to his non-IRA-based savings. At age 78, Jake decided to stop working altogether. He made up the difference in his part-time income with an immediate life income annuity, purchased with funds from inside his IRA. These taxable “qualified” annuity payments more than cover his RMDs and make up for his former part-time income. The payments are guaranteed for life and include a 66% spousal survivor benefit for the day when either he or his wife passes away. Jake now has a stable lifetime income that covers his bills, and his remaining non-IRA assets are positioned to grow undisturbed for future legacy and security.
Jane is 66 and has a nest egg of $3.4 million – $800,000 dollars of which is in IRA funds. Jane made the decision to retire early. She figures she needs roughly $98,000 a year to cover her basic ongoing expenses. To maximize her monthly benefits, Jane is delaying Social Security to age 70 and will be self-funding her income for the next four years with non-IRA dollars. At age 70, she intends to annuitize her entire IRA balance which, when combined with Social Security, should provide the income needed to cover her recurring living expenses for life. With this firm foundation in place, Jane established a separate wealth and legacy fund of $750,000 from non-IRA dollars that she plans to leave invested and undisturbed throughout her retirement. With her remaining non-IRA funds, Jane plans to pursue her interests in photography, travel, and angel investing in tech and biotech start-ups.
Mary is 86 and has just about depleted her retirement IRA funds. Her large home is paid for and she has decided to put it on the market. With the proceeds from the sale of the house, she can secure an income for life and rent a smaller, less demanding place to live in the same area. Switching to the combination of a life annuity and Social Security, she will leave the balance of her IRA – still subject to required minimum distributions – to be invested for growth and inflation protection. Mary named her son and daughter as direct beneficiaries of her IRA. When she dies, her children can inherit what remains from her IRA and spread the income payments across her oldest child’s life expectancy.
Harriet and Kevin are age 70 and 73 respectively. Both worked in relatively well-paying jobs throughout their careers. They also live in a state where housing values have skyrocketed. Like many modern families, all but one of their three children now live in another part of the country. Kevin’s work is such that it is no big deal to continue his career part-time beyond the age of 70. Harriet owns a part-time consulting business that she enjoys and happily plans to continue. Both delayed Social Security to age 70. Years ago, they downsized their home and moved into a smaller, nicer condominium more conducive to their empty-nest and frequent-travel lifestyle – much of the travel devoted to trips to visit their kids. The couple split the excess proceeds from the sale of their home between a hybrid deferred joint-life annuity, with a rider for long-term care coverage, and a non-IRA based wealth fund that they are allowing to grow undisturbed. Their plan is to continue to work part-time as long as they still enjoy doing so. The combination of part-time work, Social Security, and RMDs are more than enough to cover their current ongoing expenses. When they finally decide to quit working altogether, they plan to annuitize the funds in their IRAs with immediate income annuities, to establish a guaranteed lifetime income stream. Knowing they have a solid income backstop in place, they are comfortable leaving their non-IRA funds in growth mode and can relax about whether they will have funds needed for income in the future.
Elizabeth is 66 and a single divorcee who, after 20 years of marriage and becoming divorced over 20 years ago, now lives alone. She has worked enough years to qualify for Social Security on her own, but may also be eligible to receive additional benefits, based on the Social Security record of her former spouse. Because her circumstances are more complicated, she needs to contact Social Security to determine whether delaying her Social Security benefits beyond her own full retirement age makes sense. Elizabeth has few significant assets like a paid-off home to sell. Also, because she got started saving later in life, her IRA funds are more limited. Elizabeth’s best defense against future hardship is to lower her expenses as much as possible, continue working and continue saving. While the future will not be without its challenges, Elizabeth may live an additional 20 to 30 productive years or more. If she could find a friend or other person in similar circumstances, they might consider living together to help lower their collective cost of living. Elizabeth’s first financial priority after attacking expenses will be to establish a liquid emergency fund with at least six months of income. From there, she will need to continue setting aside funds to prepare for the coming day when she can no longer work. For long-term savings, Elizabeth has several choices. On one path, she could choose to begin funding a simple fixed deferred annuity. Such annuities can be structured to accommodate flexible contributions over time. They are also insulated from market risk and can be left to accumulate until one day, when Elizabeth decides to no longer work, she can switch on a lifetime income stream. The annuity income, along with what she receives from Social Security, can help assure that she will always have an income for life, no matter how long she lives. Another choice would be for her to save in broad-market index funds. This path has more risk, but also the possibility for greater reward. When Elizabeth finally decides to stop working, she could use the accumulated funds to purchase an immediate annuity which, combined with Social Security, would help boost her lifetime income. While Elizabeth may not be able to leave behind a significant financial legacy, she can endeavor to maintain the dignity and independence of a secure income that will always be there for her, regardless of how long she lives.
Questions or comments?
I can be reached at this link – contact Ted Stevenot.