A Comparison of Immediate Annuities & Systematic Withdrawals

There is a lot of focus put into saving money for retirement.  But when it comes time to create income from your retirement savings, most Americans don’t know where to begin.  There are a few different ways to create an income stream from your savings and each has its benefits and drawbacks.  In the article “How best to generate lifetime retirement income,” CBS Moneywatch’s Steve Vernon compares systematic withdrawals and immediate annuities as retirement income generators.

People tend to have strong opinions regarding both of these retirement income generators.  As with most financial choices, there are both bad and good ways to go about using systematic withdrawals and immediate annuities.  With systematic withdrawals, you take out a certain percentage of your investments monthly or annually to create an income stream.  There is flexibility with this plan, but also the potential that you could outspend your savings or that markets perform poorly.  Immediate annuities are different because you purchase them from an insurance company using a portion of your retirement savings.  The insurance company guarantees to send you monthly income for the rest of your life.  Your income payments will not be affected by an economic decline or you living a very long life.

With either product, it’s important to find a low-cost and efficient version because there are plenty of high-cost but low performing options out there.  Sometimes a combination of systematic withdrawals and immediate annuities is the right choice.  One of the main distinctions between these two income generators is what happens to your money upon death.  Immediate annuities do not inherently pay death benefits to your heirs.  You have to add a rider for a joint or survivorship option which will lower the amount of your monthly income payments while alive.  Any investment money left under the systematic withdrawal approach would be left to your heirs upon death.  That is of course, unless you have spent down all of the money while alive.  This is a big risk with the systematic withdrawal approach.

The CBS Moneywatch article compares the circumstances in which you essentially win with the two options.  If you chose to buy an immediate annuity, you benefit most if you live beyond your life expectancy or if the stock markets perform poorly during your retirement.  With systematic withdrawals, you (or your heirs) benefit most if you don’t live as long as expected or if markets perform extremely well.  A chart included in the article estimates the annual rate of return that you would need to get on your investments for systematic withdrawals to beat immediate annuities as an income generator.  While the rates start low for people looking to finance 10-15 years of a retirement starting at age 65, it’s a risky move to assume that you won’t have to finance a retirement any longer than that.  When looking at the advantages and disadvantages of both retirement income generators, it’s very clear that one product’s pro is another product’s con.  A combination of these two options for generating retirement income could be wise to consider.

It’s also important to keep in mind that all of these approaches have fees associated with them, whether they are from an advisor, a bond fund or an insurance company.  Systematic withdrawals and immediate annuities both have pros and cons as retirement income generators.  Speak with an expert to determine which option, or combination of them, is right when planning for your retirement.

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