CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted income for the rest of his life under each of the four options above.

Pulling money out of the portfolio works just fine for the first 10 to 15 years. Trouble is, when our fictional retiree gets beyond age 80, the risk of his money running out rises rather steeply. That risk drops when our retiree puts a portion of his assets into one or more annuities.

This hybrid approach has other advantages as well. If you rely solely on withdrawals from your portfolio and it runs dry, that's it -- you're broke. When you own an annuity, your income may fall short of your target, but it never completely stops. And there's a potential upside with a variable annuity if the stock market delivers generous returns.

Fixed vs. Variable Annuities

Fixed- and variable-payout annuities have different advantages. Using both can make your retirement paycheck more secure.

Fixed-payout annuities provide predictable income. To turn, say, $100,000 into a guaranteed fixed income for life, you would buy a fixed-payout or immediate annuity with your hundred grand, and the insurance company that issued the annuity would guarantee you a certain payment based on factors such as your life expectancy and how much the insurer felt it could earn by investing your money.

Pro: You know how much money you'll get each month.

Con: You give up access to your money. If you die immediately after buying the annuity, your heirs would receive not a cent. And if prices rise, your purchasing power declines.

Related Stories
graphic
Cut your taxes in retirement
Breaking the piggy bank
Pension vs. a lump sum payment

Variable annuities provide payments that fluctuate from month to month. You start by choosing an assumed interest rate, or AIR, which, along with your life expectancy, determines the size of your initial payment. Some insurers allow you to pick your own AIR, while others assign a specific rate, often 3.5 percent or 4 percent.

Next, you divide your investment among a number of subaccounts, essentially the same as mutual funds. If the subaccounts generate a higher return than the AIR, your payments increase. If the subaccounts earn a lower rate of return, your payments go down.

Pro: There's a good chance that your payments will stay ahead of inflation.

Con: Your cash flow will be unpredictable and can drop substantially if the markets slump. Then there are the fees: Together the annual portfolio fees for the subaccounts and the insurance charges can easily top 2 percent. And features that, say, set a minimum on how low your payment can fall can boost costs by as much as one percentage point.

How much to annuitize

How much should you consider investing in one or more annuities to create a lifetime income? There are no handy rules of thumb.

I can't imagine a scenario where it would make sense to annuitize all your assets, since that would place too large a bet on one investment and limit your flexibility for dealing with unanticipated financial demands.

Similarly, you may not need an annuity at all if you've accumulated so much wealth that the chances that you'd run out of money are minuscule.

YOUR E-MAIL ALERTS
Ask the Expert: Creating a retirement paycheck - May. 12, 2004
CNN/Money 
Personal Finance > Ask the Expert
graphic
Creating a retirement paycheck
Here's some advice for turning 401(k) and IRA balances into a steady, sustainable income.
May 12, 2004: 5:08 PM EDT
By Walter Updegrave, CNN/Money contributing columnist

Sign up for the Ask the Expert e-mail newsletter

NEW YORK (MONEY Magazine) - You have saved diligently and invested wisely. You've maxed out on every tax-advantaged retirement savings plan known to man, and you've built a tidy retirement nest egg.

In short, you've reached the end of the yellow brick road of retirement planning.

Adapted from Walter Updegrave's latest book,  
Adapted from Walter Updegrave's latest book, "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

But that's only half the equation. The other half is the drawdown phase, during which your goal is to tap your assets in such a way that you don't run out of money before you run out of time.

Unless you know that you've got a fatal condition or you're certain that you're genetically programmed for a short life, your assets probably have to last a good 25 to 35 years, possibly more, after you retire.

There are a lot of variables here, and I'll be the first to admit that things can get complicated in a hurry. But not to worry. The drawdown phase is entirely manageable if you set a low withdrawal rate -- I'm talking about taking an initial draw of 4 percent or so of the value of your portfolio and increasing that amount every year for inflation -- and adopt an investment strategy that combines annuities and mutual funds.

The annuity advantage

There is a way to virtually ensure that you'll always have money coming in no matter how long you live, and that's to buy an annuity. Payout or immediate annuities come in two flavors, fixed and variable, but both are effective tools for converting assets into income.

Basically, they work like a life insurance policy in reverse: You give the insurer a lump sum of cash in return for regular income payments until you die or for a specific period.

The trade-off: You have to give up access to your money -- and annual fees can top 2 percent of your portfolio's value.

Probability of running short
Putting some retirement assets into payout annuities can help ensure you don't run out of money.
Age Scenario 1 Scenario 2 Scenario 3 Scenario 4 
80 4% 3% 5% 3% 
85 15% 6% 15% 7% 
90 24% 14% 18% 11% 
95 32% 23% 22% 16% 
100 43% 27% 29% 18% 
 * Notes: Assumes annual expenses of 0.75 percent in a variable annuity and 0.25 percent in a fund portfolio (70 percent stocks, 30 percent bonds). Assumed AIR is 3.5%. Source: Ibbotson Associates.

Fortunately, there is a solution that gives you the security of annuities plus the flexibility and control of managing withdrawals from your portfolio on your own: Invest a portion of your retirement portfolio in one or more low-cost annuities, and keep the rest of your money in a portfolio of mutual funds and/or stocks and bonds that you can draw from to meet your living costs or to pay for the occasional splurge.

To get an idea of how this approach might actually work, consider the following hypothetical scenario I created with the help of the Chicago investment research firm Ibbotson Associates. Assume that a 65-year-old man has savings of $500,000, from which he would like to withdraw 5 percent, or $25,000, in the first year of retirement and then increase that amount each year with inflation.

Let's also assume that our retiree has four options for getting that $25,000 income adjusted for inflation each year.

  1. He can pull the required amount from his portfolio.
  2. He can get a portion of the $25,000 inflation-adjusted income by investing 25 percent of his assets in a fixed-payout annuity and the rest by taking systematic withdrawals from the remaining 75 percent of his assets that are invested in funds.
  3. He can get a portion of the income by investing 25 percent of his assets in a variable-payout annuity and the rest from his fund portfolio.
  4. He can get a portion of the income by investing 50 percent of his assets in annuities -- 25 percent each in fixed and variable annuities -- and the rest from the 50 percent of his assets in funds.

Ibbotson ran computerized simulations using long-term historical results for stocks, bonds and inflation to gauge our hypothetical retiree's chances of getting that inflation-adjusted in