Guaranteed Income for life can help peace of mind.

Creating a private pension could be just what you need to maximize retirement income.

Everywhere we look we are told to save now for our retirement years. Nothing wrong with that advice, but you should know that you’re unlikely to enjoy a lot of what you save in your retirement accounts. It’s not because of a complicated rule or tax law. It’s because of a real fear of outliving your money if you were to spend it early on in your retirement years.

As a practicing Certified Financial Planner, I spend a good deal of my time helping people with retirement saving and spending plans. On the spending side, retirees usually have a strong desire to NOT spend the principal in their investment accounts. They know that if they spend principal than they will have less money to earn interest going forward. Unfortunately, at some age, well into those retirement years, you will realize you are too darn old (you have everything you want and your spending is greatly reduced) to spend all that money if you tried.

I think deferring all that you could have done with that money when you were young and healthy only to never enjoy it in retirement is a shame and can be corrected with some good planning. One strategy you may want to consider is creating a private pension.

A pension is simply a stream of income at retirement that usually lasts for your lifetime, often times with a survivor benefit for your spouse.

Receiving a retirement pension is entirely up to you. That’s right, you can create your own pension using your own money.

HOW THE GUARANTEED LIFETIME INCOME WORKS

The income generally comes from a contract, called an immediate annuity, with an insurance company. Contractually, you give the insurance company a lump sum of money and based on your age and gender (survivor’s included if there is a survivor benefit) they make a promise to pay a fixed income over the lifetime(s) of the beneficiaries. The promised payment is most influenced by the age or life expectancy (current health is not factored in) of the recipients. The longer the insurance company expects to pay out (actuarial tables) monthly income the lower the payment will be.

Nothing Natural About Retirement

The insurance company’s payment to the beneficiary is a combination of interest and principal. Therefore, it’s much greater than an “interest only” payment from an investment would be. The difference is that when the contract’s income beneficiaries have died, the contract ends and there is nothing left to be passed on.

YOU SPEND ALL OF THIS MONEY RATHER THAN LIVING ON JUST THE INTEREST.

The advantage is a SIGNIFICANTLY larger stream of income (you get to spend and enjoy the principal from the nest egg you accumulated) with the peace of mind that you cannot outlive the payments. The downside is that it won’t be part of your legacy and pass to your heirs.

Tax Implications:

If the lump sum you use is from an IRA, then the income you receive would all be taxed as ordinary income.
If you deposit non-IRA money into this strategy, then only a small portion of the income will be considered taxable and most of it will be considered return of principal and not subject to income tax (consult tax advisor on this matter).

Here’s an example comparison for a 67 year old couple that are interested in seeing how this might work using a $500,000 lump sum.

Today an insurance company would pay them a monthly income of about $2,500 for their joint lifetimes. This amount is guaranteed, won’t fluctuate, and they cannot outlive it. The $2,500 per month equates to $30,000 per year.*
If you were to invest the $500,000 in a conservative investment, such as a Certificate of Deposit and live on your interest, you might get about 2% or $10,000 per year. Of course, you still have control of your principal in this case, but the point I was making is that you will not want to spend your principal for fear of outliving it. Thereby, never spending and enjoying all that you saved!

*You can take a little less (about $60/month) and make sure your beneficiaries would receive a lump sum equal to the remainder of the lump sum deposit which has not yet been paid to you

This is an especially attractive idea for people with people with above average life expediencies as this payment never stops so if you live past a person your age and gender’s life expectancy you will come out more ahead.

I’d love to hear back from current retirees if they think they will ever spend their retirement principal in the comment area at the bottom of the page.