Lump Sum Annuity Investment
One choice for generating retirement income is to invest in a lump sum annuity, or immediate annuity. Though a lump sum can be invested and the income stream deferred, typically the income stream trigger will be pulled immediately after investing the money. The culmination of lifetime saving occurs at the point of retirement, at which time there is a need to replace the income from working and maintain the desired lifestyle. Though the amount saved is critical, the real goal is to save enough to live the way one wants for the rest of one’s life. To achieve this, investment income will play a major role. The best way to generate reliable income is through utilizing annuities.
How an Immediate Annuity Works
The fundamentals of an immediate annuity are not complex, though the formulas and actuarial science used to determine payment amounts are highly complicated. Basically, the client gives a lump sum of money to an insurance company, which in turn begins giving it back gradually. The payment schedule can be flexible, though once determined the payments have fixed amounts and duration. The annuity owner can select a period certain payment schedule or equal payments over a set number of years. For example, lottery winnings are often paid out with a ‘twenty year period certain immediate annuity.
The million dollar prize is paid out at the rate of $50,000 each year for twenty years. A period certain payout may be selected to cover a specific income need for a certain timeframe. For example, a life insurance policy or long term care policy could be funded over ten years of premiums. The premiums could be calculated and paid for by an immediate annuity with a ten year certain payout.
Lifetime Payout Options
Lifetime payout options are self defined, providing equal payments for every remaining year of life. Payments can be calculated for one life or the life of a couple. The dollar amount of payments will likely vary between the two options as the life expectancy of each person may differ. Planning for lifetime income is a critical component for achieving the retirement lifestyle that is desired. The risk of running out of money is the worst possible scenario, but this risk can be reduced. Retirement can last for twenty or more years; taking advantage of annuities with lifetime income payouts is an important hedge against such risk for today’s families.
Calculating Lifetime Payments
The insurance company has two estimations to make for each annuity contract quote for lifetime payout options. First, they need their actuaries to provide a ‘best guess’ as to how long the annuitant(s) may live. Next, they need to estimate how much risk and earning potential exist with the amount of money and time they expect to hold it. All of these calculations are performed before providing a quote for the payments of the annuity contract.
Once agreed upon, the fixed dollar payments will begin flowing on an annual, quarterly, or monthly basis. Unless a period certain or other benefit is specified, the initial deposit is forfeited. This is true whether the annuitant survives one year or eighty years, potentially getting payments totaling far more than deposited and earned with the account. Risks exist for both sides, as well as significant potential benefit.
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Hybrid Payout Options
Some investors may be averse to forfeiting the entire principal in exchange for the peace of mind of lifetime payments. There are hybrid payout options for such persons. A number of such variations are available in combination with life and joint life payouts. One example of such a hybrid payout schedule is a lifetime payout with period certain. In this case, the lifetime payout will begin as normal. In the event that the annuitant passes during the period certain, the payments will continue to a beneficiary for the remainder of the certain period of time. This is designed to provide some legacy for beneficiaries and will generally mean a reduced payment amount.
Through the purchase of riders and certain contracts, other hybrid options could include a lifetime payout with a modified death benefit. Options such as this essentially insure against the risk of getting back significantly less than deposited into the annuity contract. Hybrid payouts can also satisfy two objectives; the need for income and the desire to leave money to family or charities.
Lifetime Income is the Key
Achieving peace of mind and reaching financial goals go hand in hand. Outside of large purchases, which are typically rare, most of life’s expenses come amortized. In other words, we pay for most things over time as we consume them. Mortgages, utilities, gasoline, and food… almost everything we buy as we need. For this reason alone, retirement savings is geared toward building a nest egg to generate an income stream. Many families follow the traditional path to reaching financial freedom almost exactly at retirement age.
Other families simply plan to work up to the time they reach such a financial goal, whether it is at age fifty or seventy. The natural progression of working income and diminishing debt will culminate at one point in time. The moment everyone hopes for is beginning retirement debt-free and substantial savings that can stand the tests of inflation, longevity, market volatility, and other risks.
By creating lifetime income streams and utilizing annuities, families can generate the retirement income needed to live the way they want for the rest of their lives. As retirement approaches, use cash flow planning to determine what portions of assets should be directed to annuities with lifetime payout options. This strategy will allow other assets to remain invested while enjoying the freedom of retirement. In cases where health or wealth provides for a long retirement, plans for a ‘rising income stream’ need to be in place. What this means is that some ‘raises’ or increases in regular income will be required as the years go by. Plan to use the remaining portfolio to generate such increased income down the road.
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