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Any type of long-lasting structure needs to have a good, solid foundation. This is also the case with regard to your retirement income. No one knows how long they will need to have income in the future, so it is essential to plan ahead for the long term.
In addition, there are also many risks that can derail your savings and your future income. With that in mind, the right financial vehicles are essential in order to accomplish a financially happy, healthy, and worry-free retirement.
Risks to Your Retirement Income
With the average life expectancy increasing, coupled with the uncertain future of Social Security, and the disappearance of defined benefit pension plans, it is more important than ever to secure one or more reliable sources of income in retirement.
When it comes to retirement income, there are actually a number of risks that you need to be mindful of – and that you must plan ahead for. These include:
- Stock market volatility.
- Sequence (or Order) of Returns.
- Healthcare/Long-Term Care Costs.
Let’s take a look at each of these individually.
Stock Market Volatility
Keeping principal safe is a goal that most investors strive for. Loss of portfolio value was all too real during the recession of 2008, as well as the more recent 2020 COVID-19 crisis (and corresponding 30% stock market drop at the onset of the pandemic in the U.S.).
Even just a small market “correction” can have significant consequences – and making up for those losses isn’t easy. In fact, the more the value of an investment falls, the higher the future return needs to be in order to just break even.
Return Required to Break Even After a Loss
|Loss||Required Return to Break Even|
Over time, inflation can also play a big part in whether or not your income keeps pace with the rising cost of goods and services that you will need to purchase in the future. Plus, because average life expectancy is getting longer, factoring in future inflation will become even more important.
For instance, using an average inflation rate of 3.22%, your purchasing power can be cut in half in just a 20-year period of time. This means that the amount of income you bring in right now would have to double in 20 years in order to maintain the same lifestyle and make the same purchases.
Sequence (or Order) of Returns
Sequence, or order, of returns risk is one that not many investors are familiar with – but it is essential to factor into your retirement income planning. This is because getting negative returns during the time period just before and just after you retire can lead to the depletion of your portfolio much faster.
As an example, if two investors each start out with $100,000 and they each opt to withdraw 9% per year from their portfolio, why is it that one of the investors runs out of money a full six years before the other – even though both of the investors attained an average return of 7%?
|Year 1||Year 2||Year 3||Ave. Return||Years Until Depleted|
Source: Government Accountability Office, June 2011.
The reason for this is because Investor #1 had a negative return in Year 2 (as versus in Year 3 when Investor #2 attained a loss). Given this, WHEN you generate a return can be just as important – if not more so – than the returns themselves.
Healthcare/Long-Term Care Costs
Another risk to your retirement income is potential healthcare and/or long-term care expenses. As we get older, we tend to require more health and medical services, as well as assistance with everyday activities, such as bathing and getting dressed.
Even with Medicare, out-of-pocket healthcare expenses can be astronomical. In fact, according to a recent Fidelity Investment study, it was determined that a 65-year-old couple who retires in 2020 can expect to pay roughly $295,000 in out-of-pocket healthcare-related costs…and this doesn’t even include the cost of a long-term care need.
Just one month in a semi-private room in a skilled nursing home can run, on average, more than $7,500. A private room can be over $8,500 per month. Even home health care can cost in excess of $4,000 monthly. So as much as people don’t like to think about it, these types of expenses must also be factored into your retirement income plan.
How an Annuity Can Be Used as Your Own Personal Pension Plan
One way to ensure that you have income for a set period of time – such as 10 or 20 years – or even for the remainder of your lifetime, is through an annuity. These financial vehicles can provide you with a way to overcome the fear of running out of income, no matter how long it is needed. And this, in turn, can allow you to focus on other, more important things, like spending time with loved ones, traveling, or just relaxing on the beach.
Annuities will typically offer several different income payout options, such as:
- Period Certain – With this option, the annuity pays out recurring income for a set number of years, regardless of how long the income recipient (i.e. annuitant) lives. If the annuitant dies before the income has stopped, a named beneficiary will continue to receive the payments until the time period has elapsed.
- Life Only – The life only payout option continues the income payments for the remainder of the annuitant’s lifetime, regardless of how long that may be.
- Life with Period Certain – The life with period certain income option provides payments for the rest of the annuitant’s lifetime. However, if he or she passes away before a certain period of time – such as 10 years – has elapsed, income will continue to be paid to a beneficiary until the end of the period.
- Joint and Survivor – The joint and survivor option pays income until the death of a second individual, such as a spouse or partner. In some cases, the dollar amount remains the same after the death of the first annuitant, and in other instances, the dollar amount may be reduced.
Is an Annuity Right for You?
While annuities can offer many benefits – including a guaranteed income stream for life – these financial vehicles are not right for everyone. The best way to determine whether or not an annuity may be a good fit in your retirement income plan is to discuss your short and long-term objectives with an annuity specialist.
At Annuity Gator, we help consumers and financial professionals understand how annuities work. We also provide annuity comparisons, so that you can see how one annuity versus another may perform.
If you would like to set up a time to chat with an Annuity Gator specialist, feel free to contact us directly at (888) 440-2468 or contact us via email by going to our secure online contact form. We look forward to assisting you.