Perspectives Online

You decide: How can you avoid outliving your income? By Dr. Mike Walden North Carolina Cooperative Extension


Dr. Mike Walden is a William Neal Reynolds Professor and extension economist in the Department of Agricultural and Resource Economics of the College of Agriculture and Life Sciences.
His You Decide column is provided every two weeks by the Department of Communication Services.
Earlier You Decide columns are available on the Web
His radio show is also available online
Photo by Daniel Kim

I've been thinking a lot about retirement recently. No, not for me, but for others. After 32 years of teaching elementary school children, my wife retired this year. Also, one of my sisters-in-law is planning to log off her computer for the final time as a college administrator.

Economically, retirement means a person stops working altogether, or at least significantly scales back their working hours. Less work time means less income. But expenses continue, and may for a long time. Indeed, thanks to modern medical technology, life spans are increasing.

Yet the prospects of a long life combined with daily expenses set up a key retirement question: How can I avoid outliving my money? No one wants to reach age 85 only to find all their assets gone.
Of course, Social Security, assuming it survives, pays retirees as long as they live. But Social Security was never intended to be the only source of a retiree's finances. For most, it will fund at best half to two-thirds of what they need for expenses.

Retirees with a traditional "defined benefit" pension have less worry about outliving their income because these pensions, like Social Security, are designed to pay the retiree as long as he or she lives. However, the percentage of workers with this type of guaranteed pension has declined.

So most retirees will have reason to worry about outliving their income. Fortunately, there is a longstanding financial product that can help.

The product, an "immediate annuity," works like this. Say you have been saving for your retirement, maybe through an IRA or a 401K or just a conventional savings account. You've accumulated a sizable fund by the time you retire. At this point you use the fund to purchase an immediate annuity, which promises to pay you a monthly amount for as long as you live.

As an example, a 65-year-old man who has a retirement fund of $200,000 could purchase an immediate annuity that would pay him $1,400 a month for life.

The alternative is to draw down on the $200,000 as you need it. The problem is that if you live a very long time, your fund will likely run dry. That's the benefit of the immediate annuity: Your money never runs dry.

However, immediate annuities certainly have drawbacks, which is probably one reason they're not more commonly used.

One problem is if you die too soon, you may not have lived enough to use all the money from your original retirement fund. The annuity then "makes" money from the unfortunate deceased.

There are some ways to handle this. You can buy immediate annuities that continue payments to a beneficiary for a fixed period, or for life, if the annuity owner dies early. The downside: These payments will be lower than in the case of standard payments that last only until the annuity owner dies.

Another issue is inflation. Inflation means that dollars in the future are worth less than dollars today. So while an immediate annuity paying $1,000 today may look good, that same $1,000 won't be nearly as good five, 10 or 15 years from now when prices are higher.

Again, though, annuity companies have come up with an answer. You can purchase immediate annuities that are "inflation adjusted" each year, meaning the payment rises with the inflation rate. Once again, the cost is that the initial payment is lower than in the standard case.

If you're young and far from retirement, then this discussion probably hasn't caught your attention. But if you're like some of my family members who are retired or close to retirement, then the question about outliving your income is a big one.

You decide if immediate annuities are an answer.