The income annuity: a life jacket for retirees

By David Machia

This article is taken from “The Income Annuity is the Constrained Investor’s Life Jacket” originally published on

For many retirees, the financial equivalent of the life jacket is an annuity. It is the one and only tool that can save a retiree’s income. And for that reason alone, his popularity should be far greater than it is.

I think of the role of an annuity in the context of an investor’s retirement income planning. In this previous article, I wrote about the characteristics that describe “constrained investors” and some of the big risks they should plan for.

david machia

And in a separate article, “How to Think About Annuities,” I suggested questions you should ask the financial professional who recommends you buy an annuity.

I want to merge these topics and delve into the retirement security challenges of the constrained investor by giving you a simple framework for determining whether you are, in fact, a constrained investor. Next, I’ll focus on a particularly dangerous issue for constrained investors: longevity risk.

Are you a constrained investor?

The good news is that constrained investors come to retirement with savings. The less good news is that the amount of money they have accumulated is not high relative to the level of income they need to produce their savings. For the purposes of the following example, I define “retiree income needs” as the amount of annual income required to fund their minimally acceptable lifestyle.

Social security and pensions will cover part of the income a retiree needs. The rest must be generated by the retiree’s savings. The difference between the two is the income gap.

Let’s take the example of a young retiree whom we will call Anne. A disciplined saver, Anne has accumulated a nest egg of $875,000 and receives a monthly Social Security retirement benefit of $2,100. For her peace of mind, Anne needs a total monthly income of $5,200. But she doesn’t know how much she can safely spend each month, or what risk to take.

Subtracting her Social Security income from her total monthly income goal, we find that Anne has an income gap of $3,100 per month or $37,200 per year.

$5,200 – $2,100 = $3,100 ($37,200/year)

The income/asset ratio

Divide the annual income you need to produce with your savings by the total amount of savings available to produce income. If the resulting percentage is 3% or more, you are a constrained investor. In Anne’s case, it looks like this.

$37,200 ÷ $875,000 = 0.0425, or 4.25%

4.25% is greater than 3%. Thus, with an income-to-asset ratio of 4.25%, Anne is a constrained investor.

Now that we know Anne is a forced investor, what does that mean? In a word, caution. Anne’s savings will be under pressure to provide the level of income she desires. She will really need the help of a financial advisor who specializes in retirement income planning and who will provide her with a formal, written plan outlining how her income will be created.

An income plan that balances safe investments with appropriate exposure to the growth potential of the stock market can provide Anne with several important benefits, including secure monthly paychecks throughout retirement. I have described such a plan here. The aspect of secure monthly paychecks adds a high degree of emotional management that allows retirees like Anne to stay consistent with investments.

Follow us on Instagram and Twitter!

Anne’s longevity risk

Is living a long life really a risk? In financial terms, this is absolutely an incredibly large risk. Anne’s mother lived to be 96 years old. What would happen if Anne survived her mother, say six years, until the age of 102? Sounds far-fetched? It’s not.

In 2020, there were 920,000 people in the United States who had reached the age of 100. It is predicted that there will be more than five million by 2058. Anne could very well find herself among this group of American centenarians.

Longevity and inflation

Adding to Anne’s longevity risk is the problem of inflation, which recently rose to 7.5%, a level not seen in the United States since the 1970s.

For Anne’s purchasing power to be the equivalent of what $5,200 a month buys today, by the last year of her retirement, Anne’s monthly income must reach $15,071. And this is based on the assumption of an inflation rate of 3%.

The dual risk of longevity and inflation should motivate any investor forced to find that balance between safe investments and exposure to the growth potential of equities.

Retirement success starts with recognizing the type of investor you are. If you determine that you are a limited investor, you should be confident in your financial security in retirement. But don’t wait to take the planning steps that will give you the best chance of having an income that keeps pace with inflation and lasts a lifetime.

You can read the original article in full on RetirementInvestor.

About the Author: David Macchia

David Macchia is an author, speaker, and entrepreneur focused on improving the current state of retirement income planning. He is the founder of Wealth2k, Inc and the developer of the widely used retirement income solution, The Lifetime Income Model®. Recently, David developed Women and Income™, the first retirement income solution developed to meet the differentiated needs and preferences of female investors. David is the author of the consumer finance book, “Lucky Retiree: How to Create and Keep Your Retirement Income with The Income for Life Model®”.

You might also like:

How to know if an annuity is right for you

Thoughtful uses of pensions in retirement

How Life Annuities Can Secure Your Retirement

Comments are closed.