Best Lifetime Retirement Income Option: Immediate Annuity vs. Systematic Withdrawal
Cashing in your 401(k) or IRA during retirement brings an important decision to be made: how to best generate a lifetime retirement income.
There are two main ways you can do so this: through an immediate annuity or by setting up systematic withdrawals. Let’s briefly describe each retirement income generator (RIG):
Immediate annuity: An insurance company accepts a portion of your savings, then sends you a monthly check for the rest of your life – no matter how long you live or how the economy fares.
Systematic withdrawals: A portion of your savings are invested, and you use a withdrawal process to create monthly checks for as long as you live – however, this may stop once funds run out or the investment fares poorly.
Comparing Each Option
While opinions on each RIG vary depending on who you ask, it’s important to look at what features they distinctly offer and what they share in common.
Right away, an important difference between both is what happens to your money when you pass away. For immediate annuities, the monthly income ends unless you have a joint and survivor benefit, in which case it ends once you and your spouse die. For systematic withdrawals, any amount left over will be inherited by your heirs instead.
With this, it’s possible to think of scenarios where one approach becomes better than the other. In effect, an immediate annuity would be better if you live for a long time, or if your investment would have suffered poorly. A systematic withdrawal would then be better if your life isn’t as long, or if your investment does well.
Using Common Case Scenarios
Let’s consider this scenario: when would one approach be better for a 65 year-old single man, a 65 year-old single woman or a married couple with $100,000 in savings.
Let’s say that an estimate of how much they can get with an immediate annuity is a lifetime monthly check of around $550. It’s then a question of how much a systematic withdrawal investment should return over various lengths of time to either match or exceed that monthly check.
So if you lived for only 10 years afterwards, you could have withdrawn more than $550 per month during that time, or withdrawn that amount and still passed the remaining funds as inheritance. A systematic withdrawal would be better in this case. But what if you live longer?
Annual Rate of Return Needed for Systematic Withdrawals to Be Better than Immediate Annuities
This chart shows how much you’d need to earn with your investment in order for a systematic withdrawal to beat an immediate annuity. Clearly, if you live a longer time, an immediate annuity would offer a better source of retirement income, or that a systematic withdrawal would need to perform really well to match it.
Assessing Your Needs
As you can see, this decision is more a matter of figuring out your preferences, including your risk appetite for investments. Where one approach seems to be at a disadvantage, the other can cover well, leading to the conclusion that combining them should work better overall, and is indeed a good recommendation.
Consider dividing your retirement savings between both RIGs so you can enjoy the best of both worlds.