Social Security and Annuities

When you think about your retirement income, what percent of it will come from Social Security? What percent will come from earned income? And what percent will come from other sources?

Social Security, which has long been the primary source of retirement income for low-income Americans, is also becoming a significant source for those with higher income as well, according to the Employee Benefit Research Institute. In 2006, for instance, Americans in the highest income quintile (more than $34,750 annual income) received 18.5% of their income from Social Security.

“Social Security is not sustainable over the long term at current benefit and tax rates,” according to the Social Security Administration’s report. “Within seven years the program will begin paying more in benefits than it collects in taxes. By 2037 the trust funds will be exhausted. At that point, payroll taxes and other income will flow into the fund but will be sufficient to pay only 76% of program costs.” Read Social Security’s report at this Web site.

Earned Income

Earned income is an important source of money in retirement. And no doubt, you likely plan to keep working — either out of want or need or a little bit of both — after you retire.

According to Social Security, earned income in 2007 represented about 29% of the average beneficiary’s total income, roughly the same percentage as in 1962. That percent is higher for high-wage workers and lower for low-wage workers.

But working in retirement isn’t a fail-safe source of income and you should consider a back-up plan. There are many reasons why twice as many workers retire earlier than planned. Some lose their jobs. Some retire for health reasons. (There’s some correlation between taking Social Security early, at age 62, and having a high body mass index, by the way.)

Income from financial capital

What are those other options? Basically, there’s one. Income from assets represented just 16% of the average Social Security beneficiary’s retirement income pie in 2007. In the future, the percent of income that comes from financial capital, including IRAs, will likely have to rise.

That’s especially so if 65% of the average retiree’s income plan is at risk, if the 29% of income you were expecting from working in retirement falls through and the 36% of income you were expecting from Social Security goes away.

Yes, it’s time to save like crazy because there are no guarantees when it comes to your retirement income plan.

However, although good trends, the early retirement and increased life expectancy demographics make retirement planning more difficult for someone that has recently retired. The likelihood of the average American outliving their retirement savings is become more and more of a possibility.

Deferred Annuities

With this in mind, deferred annuities should also be considered as a retirement option by retirees. If for example, someone lives into their 80s, but retires in their late 50s, a deferred annuity may be the correct choice depending on their other financial circumstances. They will live long enough to see their investment mature.

When selecting the best retirement annuity, retirees need to consider if they want their spouse to be able to continue receiving a steady income if they die first. It is important for an investor to understand their own needs so that they can select the appropriate retirement annuity contract.

Retirees should also consider what the likelihood is that they may need to withdraw funds from the annuity. Some annuity contracts have very high withdrawal fees even if the funds are used for emergency circumstances.

As an investor moves into retirement, their financial priorities will change. Their attention will turn to generating income from investments. The attitude towards risk for the investor should also change, and in general they will begin to move towards lower risk investment.

Preservation of their principal is also important to retirees so that they have enough savings to last throughout their lifetime and perhaps their spouse’s lifetime.

Fixed annuity sales jumped 74% over the same quarter a year ago, to $35.6 billion, the highest ever, for the three months ended March 31, 2009 the most recent data available from insurance consulting firm Limra.

Fixed annuities are a contract with an insurance company that, such as bank CDs, promise a set interest rate over a period of time. Unlike CDs, annuities aren’t guaranteed by FDIC. Instead, they’re covered by state guaranty funds.

One big reason fixed annuities are popular now: They can offer higher interest rates than bank CDs.

A fixed annuity from a top-rated company will guarantee yields of 3.3% to 3.5% for five years before resetting to a new “current” rate, according to CapitalCare, Inc.  A five-year bank CD yields an average 2.13%, according to Bankrate.com. You don’t pay taxes on annuity income until you withdraw it, then it is taxed as ordinary income.

Another reason for soaring fixed annuity sales is fear. The Standard & Poor’s 500-stock index has lost 56.7% in the previous 16 months from its high on 10/8/07 to its low on 3/9/2009, making guaranteed investments such as CDs and annuities more appealing to people who overextended their risk tolerance.

Sales of variable annuities, which allow policyholders to move money around in investments similar to mutual funds, have fallen below fixed annuities for the first time since 1995, according to Limra Retirement Research Center.