Make your money last in retirement; 5 keys

Lesson No. 5: Consider an immediate annuity

You may have read about the pitfalls of deferred annuities, which are designed as retirement-savings vehicles (see "The worst retirement investment you can make"). Immediate annuities are a whole different kettle. In exchange for an initial lump-sum payment, an insurance company promises you a lifetime stream of income -- with inflation adjustments, if you want them.

Most immediate annuities are fixed, meaning your payment is certain no matter what happens in the market. Those willing to expose themselves to more market risk for potentially higher income can opt for a variable rate.

If Horstman had put his whole nest egg into a low-cost, immediate annuity with Vanguard, he would have been guaranteed an income of $9,375 a month for life at current interest rates; the payout probably would have been higher back in 1998, when he retired. If he had wanted his payments to keep pace with inflation, he would have started with a payment of $5,878 a month.

If he'd committed a little less than half his stake to an immediate annuity with inflation adjustments, he could have taken the same cash he's withdrawing now and preserved his buying power for the rest of his life.

3 ways to undo the damage

Frey says Horstman could consider an annuity as one of three options for repairing some of the damage to his retirement plans.

Option 1: Buy an annuity

A fixed immediate annuity with no inflation adjustments from Vanguard would pay out about $22,000 a year, but Frey believes that would leave Horstman too exposed to rising prices.

"He could live another 30 years," Frey notes, by which time the $22,000 would have the buying power of less than $9,000 in today's dollars, even at a relatively benign 3% inflation rate.

An immediate annuity with inflation protection, though, would give him just $12,000 a year to start. Frey suggests Horstman consider a variable immediate annuity, which would give him about $20,000 a year to start -- with the amount fluctuating up and down, depending on the market.

Option 2: A reverse mortgage

Even riskier, he can continue on the path he's on now, hope he doesn't have any serious financial setbacks and plan to get a reverse mortgage on his home when he's 72.

Reverse mortgages are something like an immediate annuity -- you give up some or all of the equity in your home in return for a future stream of payments that can last for life. Horstman is too young currently for this option to make much sense.

"At his age, the proceeds from a reverse mortgage now would be too small to benefit him," Frey said. When he's older and his life expectancy is shorter, a reverse mortgage could help him boost his income.

Option 3: Bail on early retirement

"His best option, by far, is to face the fact that what is lost cannot be regained," Frey said. "He should reduce his IRA withdrawals to a sustainable level, probably about $12,000 annually, and get a part-time job to make up the difference."

Returning to work may not mean working forever, but Horstman probably will need to stay employed for longer than he wants.

"If his investments treat him well, he may be able to quit the job and resume higher withdrawals in 10 to 15 years," Frey said. "Harsh words, but he has to face reality."

Liz Pulliam Weston's latest book, "Easy Money: How to Simplify Your Finances and Get What You Want Out of Life," is now available. Columns by Weston, the Web's most-read personal-finance writer and winner of the 2007 Clarion Award for online journalism, appear every Monday and Thursday, exclusively on MSN Money. She also answers reader questions on the Your Money message board.

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