You have savings, but you’re worried your money won’t last. What happens if inflation continues to grow or the market crashes? Will you become a burden to your kids? Are you living the lifestyle you always dreamed you’d have in retirement? Now is the time to guarantee yourself lifetime income.
First, assess where you currently stand. Many people look to financial institutions and the media to determine what constitutes proper diversification. If you have followed their advice, your portfolio may include stock in tech like Apple, Netflix, or Tesla while also investing in oil or more traditional stocks. You likely have mutual funds, which are tied to the markets. Or your fund manager just assures you that you are diversified. However, in all of these instances, your finances are all tied to the market. It doesn’t matter which stocks you are in. If the market crashes, all stocks suffer. Proper diversification should include investments that hedge against risk—the risk of a market crash, the risk of inflation, the risk of longevity.
Varied investments among stocks does not equate to diversification because all of these investments have one thing in common: they are all tied to the stock market. This means all of your investments are at risk in the event of a market downturn or market crash. So how can you hedge against this risk?
Certainly not tied to the stock market, real assets don’t only refer to real estate, though they certainly include it. Instead, think of anything you buy that retains or increases in value as being a real asset. For example, fine art and gold are commonly collected real assets while comic books maintains its status as a real asset while there is still a market for them. When intentionally investing in real assets, you should always consider the longevity of the asset’s popularity. Baseball cards and dolls, for instance, had a good run on eBay, but when there were fewer people with an interest in buying them, the value plummeted. Used Nike Air Jordans right now are being resold for more than their purchase price, an unexpected demand for them creating a value increase, but how long will it last?
Most real assets are not used for wealth building, though some real assets increase in value over time. They are intended as a hedge against inflation. Gold is sold to the elderly not because they have any use for it, but because gold will always be valued. And no matter how high inflation rises, the value of gold will rise alongside it. In contrast, money left in a savings account most often does not gain enough interest to keep up with even the mildest of inflation, so money saved there is continually diminishing in value, resulting in what could be a significant loss in savings despite the balance never decreasing. While real assets are a fantastic hedge against inflation, real estate may rise in value faster than inflation rises depending on its location, the reason why this remains the most popular real asset for investors. The only downside to real estate is that it takes time to convert the asset to money when needed as inspections, mortgages, and the like slow down the ability to sell it.
Savings invested in an annuity or life insurance policy will hedge against market crashes since the first isn’t tied to the markets and the latter is immune to losses. Annuities can also be structured to hedge against inflation if you choose to do so, allowing distributions to begin at a smaller amount and steadily rise as time passes. Purchasers of an annuity concerned about dying sooner than anticipated may also structure their annuity to guarantee a cash payout to a beneficiary if death occurs within a certain timeframe. The flexibility in structure and guarantee of lifetime income makes annuities quite alluring to those who have substantial savings to invest towards one.
If married, another consideration must be how the surviving spouse will remain financially stable in the event of the other spouse’s passing. Here again, annuities can be structured so that a surviving spouse can continue receiving distributions until they also pass. Of course, life insurance includes a death benefit that can be used to provide stability to the remaining spouse. The death benefit can even be put directly into an annuity to, again, guarantee lifetime income to the remaining spouse.
A common problem when the urgent need for money arises is the inability to liquidate assets. Your 401k, investment portfolios, and real estate aren’t easily or quickly converted to cash. While a traditional savings account won’t hedge against inflation, it does provide liquidity.
Annuities, unfortunately, do not have liquidity. Once annuitized, the amount you have elected to receive per month is exactly what you receive. There are no advances on payments or early withdrawals. So while you gain the immense advantage of guaranteed, lifetime income, you sacrifice liquidity of the savings invested into it.
Life insurance policies, on the other hand, often have a cash value that can be quickly withdrawn to cover any emergency or need. You can choose to pay the money back on a timeline of your choosing or choose not to pay the money back at all. No penalties or tax implications are sustained, making this a good option for maintaining liquidity while also allowing the funds to grow far more substantially than they otherwise would in a savings account.
The biggest problem facing retirees today is the potential of outliving your money. Perhaps you have enough allocated to live ten or twenty years after retirement, but what happens if you live longer? Can your children afford to take care of you? What happens when you need part-time or full-time care?
You must ask yourself what your quality of life will be if you haven’t properly planned for the possibility of living to be 100 years old. Certainly, you don’t want to be a burden on family and being utterly reliant on the government is likely the least comfortable option of all. This is why diversification and a guarantee of lifetime income are so critical in hedging against the risk of longevity.
Think of all of the deductions you’ve utilized over the years: child tax credits, mortgage interest deduction, 401k contributions deduction, IRA contributions deduction, home office deduction, and more. In retirement, child tax credits are likely no more, you may be done or close to done paying off your mortgage, you are no longer making contributions to your 401k or IRA, and you no longer do work that requires a home office. In short, you’ve lost most of your deductions and now must pay taxes on 401k and IRA distributions along with Social Security earnings (which as of August of 2021 came to an annual total of $18,702.48 for the average retired worker). You will likely only be taking the standard deduction, which for 2022 is $12,950 for single filers and married filing separately, $25,900 for joint filers and $19,400 for head of household. The remaining income after this deduction in the year 2022 would be taxed as follows:
In August of 2021, the average retired worker received $1,558.54 each month through Social Security. That puts the total annual Social Security income for that recipient at $18,702.48.
Needless to say, you will likely be living off far less than you anticipated after taxes in your retirement years. This is why having a Roth IRA, Life Insurance Retirement Plan, or an annuity is so beneficial at this stage of life. All three of those income sources are received tax free, relieving you of some of this tax burden.
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