Sometimes, life just isn't fair. Despite lifelong saving and careful planning, the universe can throw a monkey wrench into your long-term security. In my role as a financial advisor, I've seen this happen in various ways:
- The market dives just as retirement begins--and it coincides with a period of higher expenses.
- An adult child gets into legal trouble, and parents foot the big legal bills.
- The retiree or an adult child goes through a costly divorce.
Of course, these are just a few examples. No matter the cause, what happens when funds run short after you've already retired? It's not easy or realistic to assume you can go back into the workforce in a position similar to your last job. In fact, it might not be practical to consider any type of new employment at all.
So, how can you fix a broken retirement? In this two-part article, I will explore three solutions: the "band-aid" approach, immediate annuities, and home equity.
The "Band-Aid" Approach
The band-aid approach should not be dismissed as too simplistic. Sometimes, small adjustments can make a meaningful difference. For example, is it possible to rent out a room in your home, take a part-time job, cut down to one car, get rid of subscriptions that are not necessary (such as premium channels and streaming services that you don't watch anymore or a gym membership that you no longer use), or sell timeshares that are not used?
Playing detective on ways to save and generate money could be all you need to make ends meet in the future. I find the best methodology is to go through every expense with the questions like "Do I need this?" "Can I reduce the expense?" "Is there a less expensive alternative?" Bill-tracking apps can help with this process. You can also look for creative ways to make extra money. Do you have old jewelry or antiques that could be sold? Are you a collector with valuable coins or artwork? What about offering childcare duties?
Earning extra money and reducing expenses by just $500 a month adds an extra $6,000 a year to the pot. If you base your retirement spending on a theoretical drawdown rate of 4% from your portfolio, this additional amount could "replace" principal of $150,000.
Anyone who has read my past articles knows that I hate annuities. In general, I believe that annuities are big moneymakers for the people who sell them, they convert capital gains into ordinary income, and they come with a hefty annual price tag. However, in some cases, some annuities can be very effective.
One example is called a “single premium immediate annuity.” Here, you give an insurance company a lump sum of money, and the company agrees to pay you a fixed monthly amount for the rest of your life. Of course, there are variations, but this is the basic structure. The advantages of these annuities include guaranteed income for life, low tax rates (assuming you fund the annuity with aftertax dollars), and the potential for a higher retirement withdrawal rate than would otherwise be available.
For a basic example, let's assume that Fred is 75 years old and in good health. His parents lived to their late 90s. His kids are now financially independent, but one ran into trouble a few years back, causing Fred to deplete some of his retirement savings. Fred needs about $5,500 a month for living expenses. He gets Social Security of $2,000 a month and has a portfolio of $600,000. If Fred withdraws $3,500 a month from his portfolio, his withdrawal rate amounts to 7%. If we assume Fred could live another 20 or more years, with inflation and taxes, there's little chance he can be sure he will have enough money to support himself the rest of his life.
Based on current reported returns, for every $100,000 Fred invests in a single premium immediate annuity, he could get $700 per month guaranteed income for life, amounting to a withdrawal rate of 8.4%. In this case, Fred could purchase an immediate annuity for $500,000, ensure lifetime income of $3,500 per month, and still retain a cushion of $100,000. And because Fred is purchasing the annuity with aftertax dollars, less than half of the monthly income will be subject to tax.
As I said, there are variations. If Fred bought this annuity and then was hit by a bus two weeks later, the insurance company would have a big win and Fred's heirs would likely be upset. If Fred is OK with a little less monthly income, he can purchase a lifetime annuity with what is called a “guaranteed period certain.” So, if Fred bought a 10-year period certain annuity, his kids would still get a payout for the remaining part of 10 years. In Fred's case, a 10-year period certain would reduce his monthly income from $3,500 a month to $3,220 a month. (A separate life insurance policy could be less expensive than the $280 a month difference, so this should also be considered.)
Single premium immediate annuities can also be a great solution for couples. In this case, the monthly payout is guaranteed throughout the lifetime of the last of the couple to die. Let's say Fred is married to Ethel, who is also age 75. Because joint life expectancy is greater than a single (male) life, the annuity’s monthly payment per $100,000 is $549. This equates to a payout rate of 6.6%--still a pretty attractive guarantee. The 10-year certain option only reduces the monthly payment by $5 to $544.
The numbers are higher if the annuitants are older and lower if the annuitants are younger. In the single annuitant case, if Fred was 80, his lifetime annuity per $100,000 would be $884 a month and his 10-year certain annuity would be $742 a month. If Fred was 70, the numbers drop to $574 and $558, respectively.
And there's one other way to get a higher payout: Get a medically underwritten annuity. Payouts of single premium immediate annuities are based on average life expectancies. But sometimes you can quality for a payout based on medical underwriting. As opposed to a life insurance policy where you want to convince the insurance company you're in good health, an annuity works differently. If the insurance company thinks you will have a lower-than-average life expectancy, it will offer a higher payout. So, if you have a history of high blood pressure, cancer, or other ailments, you might get a better deal with medical underwriting--even if you don't expect these issues to have an impact on your actual life expectancy.
Here's a true story from many years ago. I had a client, Grace, who was in her mid-70s. She decided to sell her house and wanted to use the proceeds to cover her rent at a senior living complex. She told me she expected to live a long time, and her kids were all financially secure. For that pool of money to support her monthly rent, she needed to pull 7.2% annually--a withdrawal rate I couldn't guarantee would last her lifetime. So, we went annuity shopping with the help of a qualified agent. Because Grace had some health issues in the past, we were able to find an insurance company that gave her a medically underwritten policy. They actually gave her a single life single premium immediate annuity that paid 12% annually. Grace lived to the ripe old age of 99.
If you are considering an annuity, do your homework. Work with a reputable agent or firm--or if you can, use a fee-only provider. Make sure the insurance company is highly rated. Don't contribute everything to an annuity; you still want a little nest egg "just in case." Be sure you are comfortable giving up principal and make sure your heirs are OK with it, too. Finally, have your advisor analyze the different options and safety nets.
Until Next Time
Just because life dealt you a difficult retirement challenge doesn't mean you have no options. Some detective work and creativity can help you find ways to adjust. And in the right situations, a single premium immediate annuity can solve your problem. In my next article, I'll discuss how you can use home equity to fill retirement gaps.
Sheryl Rowling, CPA, is the founder of Rowling & Associates, an investment advisory firm, and a columnist for Morningstar. Morningstar acquired her Total Rebalance Expert software platform in 2015. The opinions expressed in her work are her own and do not necessarily reflect the views of Morningstar or of Rowling & Associates LLC.