When you retire, you have the option of using some of the assets in your 401(k) plan to purchase an immediate fixed annuity to provide a steady income. Now, some employers are offering an annuity within their 401(k) that protects your savings in the years before retirement and guarantees lifetime income after you’ve retired.
With an immediate fixed annuity, the monthly payout is based on how much you put in – say, $100,000 – at the time you buy it. With the newer annuities, known as guaranteed lifetime withdrawal benefits, you would invest that $100,000 in an insured product (typically, a target-date fund) that guarantees a base amount from that point forward. The guaranteed amount is your $100,000 buy-in plus contributions you make later and any earnings on your investment, minus expenses. The base amount can go up, but it never drops below the high-water mark in the years before you retire, even if your investments do poorly.
You’ll pay for that peace of mind. The cost of the guarantee – perhaps 1 percent of your balance a year, plus investment expenses – means the guaranteed amount won’t grow as fast as the same amount in an account without the guarantee. And the annual payout – about 5 percent of the balance – is less than that of an immediate fixed annuity, currently 6.6 percent for a 65-year-old man.
The big advantage to these deals is that they protect you from precipitous drops in the stock market in the years immediately before you retire, says Steve Vernon, author of Money for Life (Rest-of-Life Communications). The trade-off is that the cost of the guarantee will eat into your returns. And although the payout is locked in at retirement, the income base goes down as you withdraw the money, so to produce a higher payout, your returns would have to exceed the amount you withdrew plus the expenses.
If you care more about protecting a chunk of your retirement savings than the effect of expenses, go with this type of annuity, or split the difference by guaranteeing just part of your savings. Don’t jump into this complicated product without getting expert advice.
Jane Bennett Clark is a senior editor at Kiplinger’s Personal Finance magazine. Send your questions and comments to moneypower@kiplinger.com. And for more on this and similar money topics, visit Kiplinger.com. Kiplinger’s has a new service to pinpoint the ideal time to claim Social Security to maximize benefits. Visit kiplinger.socialsecuritysolutions.com.
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