Q. I'd like to know how to use an annuity in a retirement mix that includes defined benefit pensions, Social Security, and investment income. My husband has a pension of $2,026 a month (with 100 percent survivor benefit), our mortgage-free home is worth $300,000, and we have $204,000 in 403(b) plan savings, mostly in stock funds.
In eight months my husband will be 62. He plans to apply for Social Security benefits of $1,300 a month. At that time I will be 58 ½ and will be eligible for an $855 a month pension. My plan also has an unusual wrinkle: I can take $855 a month for life at 58 ½ or I can take an "accelerated" pension and take $1,337 a month from 58 ½ to 62 and $713 a month at 62 when my Social Security benefits of $800 a month start.
Would it be better to take the accelerated pension? Also, would it be wise to use some of the 403(b) stock fund money to purchase an annuity to supplement our retirement income? If so, what would be the tax consequences?
We would like to have enough income to travel and enjoy our early retirement years while we are healthy.
---R.K., by e-mail
A. Let's start with the simple part. All money in your 403(b) plan will eventually be taxed, no matter how it is invested, including a life annuity.
There would be tax consequences for an annuity purchased outside of a qualified plan. A portion of the monthly life annuity income would be treated as return of original principal, which is not taxable.
Your accelerated pension option works to increase your monthly income from 58 ½ to 62 by $482 a month ($1,337 versus $855) at the expense of reducing your pension income later. From age 62 for the remainder of your life it is reduced by $142 a month ($855 versus $713).
We can answer your question by calculating how much you would have to put aside at 58 to provide that $482 a month. Then we compare it to the cost of buying a life annuity at age 62 that would provide $142 a month.
When you do the math, the accelerated option isn't a good deal. Assuming your money earns at a 4 percent rate, you would need to put aside $18,861 to provide $482 a month for 42 months.
A visit to www.immediateannuity.com, however, tells me that a 62 year old woman would have to commit at least $24,200 to buy a life annuity to provide $142 a month. Since you won't need to make that investment for 42 months, you could put aside $21,100 today, earning 4 percent, to have the $24,200 at 62.
You could use $18,861 of the 403(b) assets over the 42 month period to provide the additional $482 a month. As a result, your lifetime pension would be worth $21,100 more because it would be $142 a month higher--- so you should NOT take the accelerated pension.
Now let's consider your lifetime resources, beginning when you turn 62. You and your husband will have pension income of $2,881 a month ($2,026 plus $855), Social Security income of $2,100 ($1,300 plus $800, excluding inflation adjustments), and whatever income you can get from the $185,000 of 403(b) assets. (Remember, you've taken about $19,000 out before age 62 to give you the equivalent of the accelerated pension..) So you'll have nearly $5,000 a month of pension income plus whatever you take from the 403(b) plan.
The safest course of action would be to plan on taking no more than 4 percent a year, or $7,400, from your 403(b) assets and using it as your travel fund. Eventually, the inflation of your other living expenses would eat into your travel fund.
You could increase your travel money for ten years by earmarking a portion of the 403(b) assets for a travel fund. Setting aside $40,000, for instance, would reduce the lifetime income from the remaining $145,000 to $5,800 a year but it would give you about $4,000 a year more to spend on travel for ten years, a total of $9,800 a year. After ten years, you'd only have the smaller 403(b) plan to rely on to pay for travel and compensate for inflation.
Another option is to learn, starting now, how to make your travel dollars go further by learning about organizations like Elder Hostel .
Scott Burns is the retired Chief Investment Officer of AssetBuilder, the creator of Couch Potato investing, and a personal finance columnist with decades of experience.