What is Income for Life and How Does it work?
You often hear of investment vehicles and advisors talking about creating "Income for Life". I don't know about you, but income for life sounds like a pretty good idea to me. That being said - there is a lot to know about exactly how it works, and more importantly what are you paying to create that income. As the old saying goes: There's no such thing as a free lunch. Read on to find out more.
The Problem: Needing to Draw Income in Retirement
For most folks, when you finally get the chance to retire you will need to supplement your income from your portfolio. That's a very normal thing in retirement but it can also be a scary thing. Study after study shows that the top fear of retirees is running out money. What if you need to draw from your portfolio and you live long enough to exhaust all your funds? No more money to draw from means no more income. That's not an advisable option for most. Enter: a slew of products designed to create income streams in retirement. That's what we're going to discuss today.
Option Number 1: A Systematic Withdrawal
The first option to drawing from your portfolio in retirement is just to take distributions as needed. This can be done on an ad hoc basis, or as part of a regular recurring (systematic) distribution. Often folks will draw a specific amount from their portfolio each month and have it direct deposited to their bank. It looks a lot like a paycheck or pension check in that way. That being said - this isn't necessarily income for life. It depends on how much they draw, how long they live, and how big their pot of money was to begin with. Think of it this way - If I retire with $50,000 in my portfolio, and I draw $2,000 a month..... chances are I will not have income for life, unless I live a very short life! If you go this route you need to plan accordingly for a sustainable withdrawal rate. This means drawing enough that you have a high likelihood of not running out of money. For some people - those with good longevity in their family, and who believe they will live a long time, or those who don't like the uncertainty of potentially running out of money, this option is not a good fit. If you have concerns about this, you probably want to read on for some other options.
Option Number 2: Use an Income Rider
An Income Rider is an add on to an investment account, typically an annuity that will provide lifetime income. It provides a specific amount of income that will continue for your lifetime, sometimes for the lifetimes of both you and your spouse. Sounds like a great deal right! No more running out of money! Here's the rub - the amount you can draw is dictated by the insurance company based upon the size of your account, your age, and whether they are covering your lifetime only, or that of you and a surviving spouse. Here's the second drawback - there is a fee for this feature (remember: No free lunches!). Depending upon the circumstance sometimes this can still be beneficial. Here's an example - you are retiring and you have an income gap of $1,000 per month, so you need to find a way to create $1,000 each month from your portfolio. Additionally everyone in your family has lived beyond age 90, and Grandma Gert made it to the ripe old age of 107! You are healthy, and while no one can predict the future - you anticipate being here for a long time. You may have a higher concern of depleting your portfolio than someone suffering from a critical illness who has a family history of shorter than average life expectancies. In that case it might be worth the additional cost to have the security of receiving a monthly distribution without worrying about running out of money. Additionally, and this is important - an income rider is NOT annuitization. What that means is that you are drawing from your account. Should your account go to zero you will still receive a monthly check as long as you are alive. Should you pass away while still having an account balance the remainder of the account is payable to your beneficiaries. So really what is happening is that you have taken option 1 (drawing from your funds) and paid a fee to add protection against living too long and outliving your money. That is different than annuitizing an account, which is option 3.
Option Number 3: Annuitization
The last option we'll cover today is annuitization. Oftentimes people confuse this option with the income rider we covered in option 2. Annuitizing an account is something that is also done with an insurance company using an annuity. The difference is this - rather than an add on to an account allowing for lifetime income like a rider - annuitizing an account is trading that asset (your account value) for an income stream. Typically this will provide a higher amount of income than a rider, but you no longer have access to the account value because you traded that for a lifetime income stream. There are a number of ways to decide how long the income lasts and whether there is any payout to a beneficiary upon your passing, but the short version is - you are trading a pile of money to an insurance company for a series of payments. This can also be a viable option depending on how much money you need and what your pile of money looks like to start with. You can often solve a larger income gap with a smaller pile of money than in option 2, but you no longer have access to those funds once you annuitize.
The first step to deciding whether any of these options are for you is to understand what your income and expenses look like in retirement. From there you can familiarize yourself with the options to create income and whether you will need a special tool to meet your needs. As always, if you have questions about this stuff - get in touch! We're friendly people and we love talking about this kind of stuff!