Episode #64: Using Annuities to Create a Guaranteed Income Floor

Are you worried about being able to cover your day-to-day expenses once you retire? One approach is to look towards incorporating the three sources of fixed income into your overall retirement strategy.

In this episode of Money Script Monday, Brian explains how an annuity can be utilized to create guaranteed income to cover both your essential and discretionary expenses while in retirement.


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Video transcription

Hi. Welcome to another episode of Money Script Monday. My name is Brian Manderscheid. Today, we are going to talk about using annuities to help create an income floor.

This topic is very important to me because my parents have used this strategy successfully to create a happy and stress-free retirement.

Basically, their fixed income covers their essential expenses which allows them to worry less about running out of money, or the daily stock market gyrations, or the negative news cycle that comes our way.

Instead, it allows them to focus on the things they want to do, like travel, spend time with the grandkids, and do things within their community.

You too could have this happy, successful, and stress-free retirement if you use some of the items that I'm going to outline here today.

What I want to talk about are the types of expenses you'll have in retirement, the three sources of fixed income, and a scenario where we'll use an annuity to help create an income floor.

Types of Expenses

First, types of expenses. There are only two types of expenses that you'll have during retirement: your essential and your discretionary.

Types of Expenses

Your essential expenses, think of those as your needs, the expenses that you absolutely need covered during retirement.

These would be things like household, your mortgage or rent, property taxes, utilities, automobile transport, your fuel costs, maintenance, insurance, living expenses, food, clothing, and toiletries.

And lastly, medical health, your medical expenses and your health insurance premiums.

Your discretionary expenses are everything else, your wants.

Those would be things like entertainment, dining out, travel and hobbies, the things that you wanted to do during your working years, but maybe didn't have the time or resources to do so.

The things you put off.

So, we talked about the types of expenses that you'll have in retirement. Let's talk about the three sources of fixed income you'll have as well.

Sources of Fixed Income

Believe it or not, there's actually only three sources of fixed income that provide guaranteed lifetime income. Those are Social Security, pensions, and annuities.

Sources of Fixed Income

The first type of fixed income we'll talk about is Social Security.

Think of Social Security as an annuity, or fixed income, that is backed by the federal government.

Now, Social Security is on shaky grounds here today. And there is a chance that you may experience less Social Security than projected over your lifetime.

The second type of fixed income is pensions.

Think of pension as an annuity or fixed income, that is backed by a corporation, maybe state, or a municipality.

Very few people have pensions today. Many corporations have shifted from defined benefit pension plans to defined contribution plans, like 401(k)s.

And lastly, the third type of fixed income would be an annuity.

Think of an annuity as lifetime guaranteed income that is backed by the claims paying power of a highly rated insurance company.

If you don't have enough Social Security and pensions to cover your essential expenses, an annuity is a great way to bridge help bridge the gap to help create that income floor.

We talked about the types of expenses, essential and discretionary, and three types of fixed income.

The last thing I want to do is talk about a scenario where we incorporate an annuity to help create an income floor.

Example Scenario

For this scenario we're going to be working with a 61-year-old couple. They want to work five more years and retire at age 66.

Example Scenario

They have an $8,000 a month income goal during retirement.

Out of that, $6,000 a month is essential, their needs. And $2,000 a month are discretionary, their wants.

If we take a look at their current scenario, they have $700,000 today, saved up in retirement assets. And over the next five years with contributions will grow over time.

Current Scenario

In regards to their fixed income, they currently have only Social Security, which based on current assumptions, we'll calculate at $4,500 a month at their full retirement age.

Again, they don't have any pensions. So, that leaves them with a $1,500 a month essential income gap.

Meaning that their current fixed income actually is less than their essential expenses of $6,000.

They'll need to actually drain down their assets to cover those essential expenses.

That puts them at risk of things like longevity risk, living too long, stock market risk, sequence of returns risk as well.

For this couple, what do we recommend to create an income floor?

Recommended Scenario

Well, what we did is, we actually moved $280,000 today, which represents roughly 40% of their portfolio, into an annuity.

That creates guaranteed lifetime income, over both lives, meaning that income will continue until both spouses pass away.

It actually creates $1,500 a month of income that will increase over time to help offset inflation, which is another very important risk that retirees face.

You'll notice that we only moved 40% of their portfolio into an annuity.

Now, as far as diversification goes, many people will choose to put a portion of their money in fixed income, traditionally bonds, and a portion in equities for growth.

We're doing the same thing with this strategy except for our fixed income is not bonds. We're actually using an annuity instead.

If we look at their fixed income, again the same $4,500 a month of Social Security, assuming we don't maximize and take benefits at age 70.

Plus, their guaranteed lifetime income from the insurance company, we now have $6,000 a month of guaranteed lifetime income to cover their essential expenses.

The remaining $420,000 plus what they are going to contribute over the next five years, and a reasonable rate of return of 5%, their $420,000 actually grows almost to about $700,000 by the time they retire.

If they take a little short of a 3.5% withdrawal rate, that will actually create $2,000 a month of income which will cover their discretionary expenses.

So, what did we talk about today? We talked about the types of expenses, essential and discretionary.

We talked about the three sources of fixed income: Social Security, pensions and annuities.

And lastly, we talked about a scenario where you use an annuity to help create an income floor.

Believe it or not, this is not a new strategy.

Major institutions, universities, nonprofits, even the federal government have actually done extensive studies leading to the conclusion that retirees should look towards annuities in conjunction with pensions and Social Security to help create an income floor, so that their essential expenses are covered through their fixed guaranteed income.

You too could have that same result of a stress-free and happy retirement if you use the strategies we outlined here today.

With that, folks, thank you very much for attending today. Have a good day.

About Brian Manderscheid

Brian Manderscheid is the Vice President of Case Design at LifePro. He works with financial professionals designing advanced case illustrations that are built for longevity and are always in the best interest of the client.


This information is meant for educational purposes only.

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