Do you need annuity income?

It's actually pretty easy to figure out whether you need an annuity and how much annuity income you should have.

You’ve saved your whole life to be able to afford a comfortable retirement, hopefully free from significant financial stress. Now the time is approaching and it may seem pretty stressful. Do I have enough saved? How much can I spend? Should I have an annuity? Fixed annuity or variable annuity? There are lots of questions!

You need to know how much you want to spend as a percent of your savings and you need a safe spending rule like the Feel Free spending approach or a fixed spending percentage like 4% or 3%.

In order to answer the questions, you’ll just need this basic information:

1. Your estimated account balance at retirement

2. Your desired level of spending

3. A retirement spending strategy like 4% per year or divide your age by 20.

Annuity income

Annuities are called guaranteed lifetime income and they come in many forms – fixed annuities, variable annuities, deferred income annuities, and more. The key thing is that they last for your lifetime. That enables you to safely spend more. So, if you want to or need to spend more than the spending rule allows, buying an annuity can push your level of spending up and keep the spending from the rest of your savings within your desired limit. As a rule of thumb, even an annuity won't help you spend more than your age divided by 10. For example, if you're 65, and have savings of $800,000, spending more than $80,000 a year above your Social Security and other pension income has a high potential to deplete your savings.

Calculating what you need

Use this form or follow the process below to determine how much guaranteed income makes sense for you.

1. Estimate your account balance plus other savings at retirement. For most portfolios, using a 5% return until retirement should provide a reasonable estimate. (TotalSavings)

2. Determine your desired level of spending, adjusting the amount with estimated inflation by 2.5% per year. (TotalSpendAmt)

3. Subtract any anticipated income, including Social Security or pensions from TotalSpendAmt (#2) to determine the spending that you will cover with your savings. If you want to retire before your income starts, reduce the amount by 5% for each year that your retirement start date precedes the income start date. (DesiredSpendAmt)

4. Determine your safe spending level at retirement as a percentage of your savings using any spending strategy that you feel comfortable with. Using the “Feel Free” strategy, at age 70, your safe spending level is 70/20 or 3.5%. (SafeSpend%)

5. Determine your safe spending amount by multiplying your TotalSavings (#1) by your SafeSpend% (#4). (SafeSpendAmt)

6. Determine whether you need guaranteed lifetime income.

7. If your DesiredSpendAmt (#3) is less than your SafeSpendAmt (#5), then you’re set. You can spend from your savings without too much concern that you will run out of money. You are likely to be able to fund a significant bequest. Stop here and look forward to a wonderful retirement.

8. If your SafeSpend% (#5) is greater than your age divided by 10, then you should consider working longer or cutting back your planned spending. You won’t be able to spend at your desired level without a significant chance of running out of money.

9. c. If your DesiredSpendAmt (#3) is greater than your SafeSpendAmt (#5), but not bigger than your age divided by 10, then purchasing a lifetime income product will help you reach your spending goal. Go to step 7.

10. Determine the percentage income that an annuity will provide. If you don’t have an actual annuity quote, then use your age divided by 10 as a rough approximation until you get a more accurate number. Different types of annuities provide different percentages of income. Variable annuities are likely to provide the highest potential spending. (AnnuityIncome%)

11. The amount that you should spend on an annuity in order to meet your desired spending goal is equal to

(DesiredSpendAmt – SafeSpendAmt)/(AnnuityIncome% - SafeSpend%)

= (#3 - #5)/(#7 - #4)

Buying this amount of annuity income may enable you to spend at a safe level and is likely preserve your level of savings through retirement. Before buying an annuity, consult advisors, educate yourself about the many varieties of annuities and carefully consider your situation.