Should Annuities Provide Your Retirement Paycheck?
With traditional safety nets such as company pensions and Social Security dwindling, many of the 78 million baby boomers are left trying to answer one question: “Who’s going to pay my retirement paycheck?”
Annuities are one investment that more and more prospective retirees are considering. These financial products are created by the insurance industry, and offer a lot more flexibility and advantages than other investments. Here are a few reasons why you should think about adding them to your retirement plan:
Monthly Paychecks and Playchecks
Which day of the week do you spend the most money? For most, it’s Saturday. The day you retire, every single day becomes like Saturday. So in addition to paying monthly bills, you will be shopping, golfing, and vacationing more frequently. You’re going to need a guaranteed source of income to help make ends meet (paycheck) and to fund all the extras (playcheck).
The lifetime income annuity, what many insurance companies call a SPIA (Single Premium Immediate Annuity) is one tool that can help cover your expenses. Quite simply, in exchange for one, upfront, lump-sum payment, the insurance company provides you with a guaranteed monthly paycheck. The payments can be for a specific time period (e.g., five years) or for life. Essentially, the lifetime payment option allows you to create your own pension from your savings.
Income for Life
People are living longer and longer which means you are going to need more money. For instance, if you have a husband and wife who are age 65, there is a 50/50 chance that one of them will live to be age 92, and 25% chance that one lives until 97. These trends represent an amazing turn of events considering that just 100 years ago, life expectancy was closer to age 50.
When it comes to retirement planning, there are many risks: market risk, inflation risk, deflation risk, the risk of needing long term care, and more. However, the No.1 risk is longevity risk--the risk that you will outlive your resources. Longevity risk is actually a risk multiplier: the longer you live, the more exposed you are to all the other risks.
In order to retire optimally, you have to take longevity risk off the table. Social Security and pensions can help you manage longevity risk. But with many companies no longer offering pensions, and Social Security benefit levels facing an uncertain future, you will have to rely on your own savings and investments. The SPIA is one of the only financial products that can provide a guaranteed source of income for life. The payouts are based on factors such as your age and the prevailing interest rates at the time you purchase the annuity and can be paid over one life or joint lives (e.g., husband and wife).
A Safer Investment
The worst time for your investment portfolio to take a hit is the five years before and five years after the day you retire—some have called this time the “retirement red zone.” Lose money in this segment and it will greatly impact how you can spend and withdraw money throughout your entire retirement.
We all know what happened to the markets in 2008 and 2009, and for some boomers close to retirement, the financial panic may have had a devastating impact on their portfolio.
Annuities provide a way to grow your investments without be subjected to big market declines and avoid the dismal interest rates of money markets and CDs. While the SPIA is useful for providing a lifetime income, another type of annuity allows you to invest in stock mutual funds while providing various types of protection for your principal. Some of these variable annuities even allow you to invest in the market while guaranteeing that your investment won’t drop below what it started at.
Additional Considerations
As with any investment, you need to be very careful before putting your hard-earned money into anything. If you want to explore investing in an annuity, there are some things you need to be aware of and consider.
First, the contract terms for annuities are often complex. You need to work with a trusted advisor to really understand what you are purchasing. Make sure to identify any fees before signing anything, and do your due diligence and ask about annual fees and hidden charges. Ask if there are additional fees, surrender charges, and early withdrawal fees. Also, be wary of any annuity that pays the financial advisor more than 4 to 6 percent in commissions.
Next, remember that annuities such as a SPIA may not have inflation protection. Therefore, fixed annuities should only be a piece of your investing strategy and other investments in your portfolio need to compensate for inflation. Investing in commodity funds, energy, and growth stocks can be a good way to hedge your bets. Also, many SPIA’s do allow you to have your guaranteed paycheck increase every year by 1% to 5%, which seniors often find a wise choice.
Last, be aware that current interest rates will affect the monthly payouts from an annuity. Lower interest rates will mean smaller payouts, since your payments are based upon a combination of your original investment, interest rates, and mortality credits. Interest rates do matter, but it’s only one piece of the equation. Also, the older you are, the less these interest rates will matter when the insurance company calculates your income amount.
Is An Annuity Right For You?
So, is an annuity a good idea for you? That is for you and your financial advisor to determine, but it is certainly something you should strongly consider. For most retirees, Social Security is barely enough to get by on and benefits are expected to decrease further in the future. If you don’t have a pension, an annuity can serve as its replacement and as a means to guarantee that week in and week out you have enough money to cover your basic expenses.
Tom Hegna is the author of the book Paychecks and Playcheck: Retirement Solutions For Life.