Perhaps you are familiar with an annuity. The basic premise is that you convert a lump sum of money into a stream of income. Unlike an investment, once you commit a fixed amount of money to the insurance company, that company is contractually obligated to provide you a minimum level of income with the option to continue receiving it as long as you live. All guarantees are backed by the financial strength of the issuing insurance company.
An annuity is similar to Social Security benefits or a company pension plan in that it generates income from money over which you have little or no control. However, an annuity gives you many options to design your own income plan. It can offer flexibility in terms of how much income you’ll receive, as well as how much and how long, based on the premium you pay and the terms of the annuity. Additionally, many annuities offer features that enable access to funds for emergencies, health concerns, a surviving spouse and even beneficiaries. That said, it’s generally not a good idea to put all of your eggs in this basket. Think of an annuity as a guaranteed source of income in a well-diversified financial strategy.
Annuities include many options, ranging from immediate annuities to fixed, fixed index and longevity annuities. Each policy varies by issuer, and many can be customized with optional features and riders, which may require an additional fee. Keep in mind that annuities are designed for retirement or other long-term needs. They provide guarantees of principal and credited interest, subject to surrender charges. That’s why it’s important to work with an experienced financial professional to help determine which option is appropriate for your situation.
A common question among those planning for retirement is: Why purchase an annuity when the market is performing well? Remember the adage: What goes up must come down. If and when the market experiences a decline, your potential profit is reduced and your income may drop. If you sell out of the market before it goes down, that’s some pretty good market timing. The problem, however, is that to take advantage of a subsequent market recovery, you might have to buy back in when prices are on the rise – which means you’ll lose some of that profit you earned.
The bottom line: Once you lock in income payments, that’s what you get. They are unaffected by market fluctuations. If you are near or in retirement, an annuity can help provide the income you need without your having to be concerned with day-to-day market moves that could potentially impact both your short- and long-term retirement income.
It’s also worth considering that when you purchase an annuity using profits from stocks sold when the market is up, you’ll have more money to purchase the annuity, thus yielding higher income in retirement. If you’re going to buy an annuity, that may be a good time to do so.
An annuity can also help provide income protection at the beginning of retirement. That’s because if you retire earlier than expected, converting a portion of your assets to an immediate annuity will enable you to begin taking income right away. In doing so, the rest of your retirement portfolio has the opportunity to continue growing and you may be able to delay drawing Social Security benefits so they continue accruing. This is important to consider because research reveals that 37 percent of older workers retired earlier than they had planned.1
An annuity also can provide income for loved ones after your death. One way you can do this is by choosing a “period certain” option. For example, instead of lifetime income, you may choose to receive income for 30 years. This means that even if you pass away after 10 years, your designated beneficiary would continue receiving that income for another 20 years.
An annuity can offer the flexibility to address several different needs, including retirement income, access to emergency funds (some annuities allow you to withdraw a certain percentage each year without a penalty), payouts to assist with the costs of long-term care, and even inheritance proceeds. With an annuity, these options can be included as part of the contract’s guaranteed structure at the time you purchase it. While an investment portfolio may be able to pay for these needs, you might have to sell when the market is in a decline. In such a case, you would lose both money initially and the opportunity to recover lost gains on those sold assets.
Many of those in the financial industry recognize the value of an annuity within a broader retirement strategy. One study found that by purchasing an annuity contract, a retiree can improve the chances of his portfolio lasting to age 95 by nearly 20 percentage points when compared to a pure investment portfolio.2 Another study found that a 401(k) plan investor with at least $65,000 would be better off if he put 10 percent of those assets into a deferred annuity.3
Keep in mind that with an annuity, it’s all about the guarantees. If you’re a planner and you want to know how much guaranteed income you can count on in retirement, purchasing an annuity may make sense for you.
If you’d like to learn more about how an annuity could fit within your overall financial strategy, please feel free to give us a call.
1 Alicia H. Munnell. Marketwatch. Feb. 27, 2019. “Why do 37% of older workers retire earlier than planned?” https://www.marketwatch.com/story/why-do-37-of-older-workers-retire-earlier-than-planned-2019-02-27. Accessed May 9, 2019.
2 Michael Finke, Ph.D., CFP®, and Wade Pfau, Ph.D., CFA®. Principal. “It’s more than money.” https://landing.principal.com/more-than-money. Accessed May 24, 2019.
3 Olivia S. Mitchell. Knowledge@Wharton. May 2, 2019. “Can Annuities Help Grow Your Retirement Nest Egg?” https://knowledge.wharton.upenn.edu/article/annuities-retirement-income/. Accessed May 9, 2019.
We are an independent firm helping individuals create retirement strategies using a variety of insurance and investment products to custom suit their needs and objectives. This material is intended to provide general information to help you understand basic financial planning strategies and should not be construed as financial or investment advice. All investments are subject to risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values.
The information contained in this material is believed to be reliable, but accuracy and completeness cannot be guaranteed; it is not intended to be used as the sole basis for financial decisions. If you are unable to access any of the news articles and sources through the links provided in this text, please contact us to request a copy of the desired reference.