Guaranteed income plans are financial instruments that will deliver predictable income, typically in retirement, to help fund basic living expenses once regular paycheck income ceases. Most guaranteed income plans utilize annuity, pension, or insurance-based income options, providing a steady, predictable stream of income to protect against volatility in the markets. For those new to this concept, the primary benefit is the predictability of income and reduced anxiety regarding market fluctuations. This article discusses where guaranteed income fits into a comprehensive retirement strategy, what factors should be evaluated prior to selecting a plan, and potential pitfalls that can limit one’s ability to remain flexible.
1. Exactly What Does “Guaranteed Income” Mean?
A guarantee is only as good as the entity backing it. The majority of all guaranteed income plans rely on an insurance company or pension sponsor to fulfill their obligations.
Some popular guaranteed income plan types include:
- Immediate Annuities: Pay a lump sum to receive immediate income.
- Deferred Income Annuities: Receive income at some time in the future, typically at a specific age.
- Fixed Annuities: Provide a stable rate of growth and may offer additional income options.
- Pension Benefits: If your employer offers a pension program, you may have access to a guaranteed lifetime income source.
When referring to a “guarantee,” the typical reference point is the contractual obligation of the provider, not a market-based guarantee. However, inflation and taxes can erode your purchasing power regardless of whether there is a guarantee.
2. The Functionality of a Retirement Strategy
Guaranteed income provides a foundation upon which to create a retirement strategy that addresses the “needs” component of retirement expenses. The main purpose of guaranteed income is to assist in reducing the probability of depleting one’s assets over the course of a lengthy retirement.
Common purposes for which guaranteed income can be utilized:
- Provide for the Essentials: Basic living expenses such as housing, food, utilities, medical care, insurance, etc.
- Smoothen Cash Flow: Ensure a predictable and reliable monthly income for budgeting.
- Reduce Pressure to Time the Market: Reduce the necessity to liquidate investments during a downturn.
- There are a few ways to conceptualize guaranteed income within the framework of a retirement strategy:
- Floor: Guaranteed income + Social Security + pensions = Core expenses are covered.
- Upside: Invested assets can focus on generating growth to fund discretionary expenses related to travel, gifting, etc.
3. What Should I Evaluate Before Purchasing a Guaranteed Income Plan?
More so than the label itself, the specifics of the plan are the most important consideration. Two plans may have identical labels (i.e., “Lifetime Income”), yet have vastly different trade-offs.
A functional list to consider includes:
- Terms of Payout: At what time will income commence? For how long will it last? Will it be paid monthly, quarterly, annually, etc.?
- Protection Against Inflation: Are cost-of-living increases, or “step-ups”, available as part of the plan?
- Costs and Pricing: Commissions, rider fees, and the spread between value and payout.
- Creditworthiness of Financial Institution: Insurance ratings, and overall financial stability of the insurer or sponsor.
- Liquidation Limitations: What surrender charges, withdrawal restrictions, or “lock-in” provisions apply?
- Options for Survivors: What is the treatment of a surviving spouse or heirs after death?
Questions to ask:
- What total income will I expect after taxes?
- What happens if my retirement commences earlier or later than anticipated?
- How would the plan perform if inflation remains high for several years?
4. How Can I Utilize Guaranteed Income While Maintaining Flexibility?
One common error is committing too many dollars too early. Many retirees require flexible assets to cover expenses associated with medical issues, home repairs, and family needs.
Functional methods to maintain a balance of stability and control:
- Partial Allocation: Maintain a portion of invested assets in liquid investment vehicles and/or cash reserves.
- Laddering: Commence income at various ages.
- Match to Needs: Fund essential expenditures and not all discretionary expenditures.
- Evaluate Timing: Purchasing at a later time may result in higher payouts; however, delaying purchase has trade-offs.
Additionally, coordinating the timing of other retirement elements, including social security timing, debt repayment, and required minimum distributions (RMD) from qualified retirement accounts, can also enhance the effectiveness of utilizing guaranteed income.
Conclusion
Guaranteed income plans can serve as a solid base for achieving long-term retirement objectives by establishing a stable, predictable income “base” that can address essential retirement spending. To maximize the effectiveness of a guaranteed income plan, it is recommended to use a holistic approach that combines the guaranteed income plan with liquid savings and growth-oriented investments. As with any financial product, it is crucial to carefully select a provider that meets one’s requirements, clearly understands the terms and conditions of the plan, and avoids locking up more capital than is necessary to achieve maximum flexibility. As long as a plan is implemented with realistic expectations and limitations, a guaranteed income plan can function as a disciplined, strategic component of a retirement plan for security – not as a replacement for planning.