Are you a retiring American uncertain about your financial future, know that annuity is a secure means to avoid outliving assets; however, you have to consider the fees. To date, there is probably no investment product that has faced such a broader spectrum of reactions than retirement annuities. The core notion behind such products i.e. a guaranteed income stream, usually for the lifetime, seems quite appealing to the majority of the retiring Americans as the trend of pensions doesn’t seem to continue in the future. These Americans need to support their social security through a stable revenue stream and thus, are interested in annuities that offer a steady income after retirement.
What is Retirement Annuity
In its simplest form, an annuity is the insurance product with underlying guaranteed income. It involves keeping aside a sum of money and getting regular payments for a specific period. This may be the ongoing paychecks guaranteed either for the next one or two decades or a lifetime.
Through annuity, retiring Americans get the security they need at this age. Besides Social Security, they need stable retirement income.
The Current Outlook
The significance of the annuity can be determined by the surprising stats issued by the Bureau of Labor Statistics in 2018, stating that merely 17% of the private-industry labor force could access some kind of pension as a part of their employer’s benefit plan. The percentage was 18% in 2011, while it was as high as 35% till the 1990s. Defined contribution plans like 401(k)s are one of the only few plans available to workers now, with a lump sum as the only payout option. This is not sufficient to ensure a steady income for the retirees for their lifetime.
Moreover, only 25% of boomers have reported having sufficient retirement money, Insure Retirement Institute reveals. The boomers who are satisfied with their financial preparation for retirement merely account for 28%, while 42% don’t have any retirement savings or plan.
It is to be noted that as per many types of research, approximately 63 million Americans are deprived of income security at the time of retirement. Having limited knowledge, workers just keep accumulating assets without realizing how to turn those into steady income in the future, which is a crisis, as per Alliance for Lifetime Income.
What Benefits Annuity Brings for Retirees?
The most convincing case for the retirement annuity is that it usually offers income one can’t outlive (though few just payouts for a specific frame of time). That’s not essentially the scenario with traditional investments unless one’s nest egg is principally large. For people having modest means, annuity guarantees to supplement their Social Security, even if they live to be very old.
Another great benefit of retirement annuity is related to their tax-deferred status. With other common retirement investments, like CDs, a person has to pay a lender at the time of maturity. With annuities, however, a person doesn’t owe anything to the government until they withdraw those funds. That feature provides owners a kind of control over the time to pay taxes. Leaving funds in a deferred annuity cuts one’s Social Security taxes, as one has less taxable income when they delay their withdrawals.
If the annuity is variable, then its payout is based on the company’s performance; however, the fixed annuity provided fixes return rate for a designated period. For people seeking predictable income, this thus seems a better option than locking money into corporate bonds and equities.
In the Light of Stats
Greenwald & Associates and CANNEX Survey 2018, consisting of over 1,000 respondents, aged between 55 and 75 years, with over $100,000 as household assets, found that 73% of them considered guaranteed income big support to their Social Security, while over 50% reported concerns over their long-term affordability for their healthcare and living expenses. 46% suspected to outlive their retirement savings.
Retirement Income Alternatives
In absence of pension, there are certain alternatives for generating retirement income, including:
- Purchasing rental properties
- Managing rental properties
- A part-time job
- Purchasing a sound long-term annuity contract
Annuities are developed to ensure a steady income stream in retirement and they imitate life insurance policies to some extent; i.e., they offer protection to your family or dependents in case of your death.
Types of Annuities
- Fixed Annuity
People can usually purchase a retirement annuity offering either a lump sum payment option or a series of payments. In this annuity, you know in advance the amount of money to be received after the start of the annuitization stage i.e. a time when the insurer begins making payment back to you. It happens as the rate of return is fixed for the specific time frame; probably years or for life. Usually, that rate is equivalent to what a certificate of deposit (CD) would offer, so they are pretty conservative. Other fixed annuities termed income annuities (immediate and deferred), based on one’s age, can give rates that are much higher than the CD rates and the most bond coupon rates, but with higher safety cover than bonds.
- Variable Annuity
Variable annuities function differently. In this annuity, the return is based on the performance of a blend of stock and bond products, named subaccounts, that a person selects. There’s a bigger prospect for growth than that of a fixed annuity; however, it usually comes with higher risk. The insurer, though, may permit a person to buy a rider that delivers a guaranteed minimum withdrawal, even in case of a poorly performing market.
- Deferred Annuity
A deferred annuity is more like a long-term tool. After making the payment, a person cannot collect before a specified date. Before a person gets to that date, their money enjoys a chance to either accrue interest (i.e. fixed annuities) or get benefitted from the market gains (i.e. variable annuities).
- Immediate Annuity
In an immediate annuity, a person pays the insurer a lump sum and then begins collecting regular payments immediately. Some elder adults, for instance, may decide to keep a few of their nest eggs into the annuity once they retire to guarantee a steady income stream.
The Cons of Annuity
Though retirement annuities are a great source for retiring individuals to support their Social Security and not to outlive their retirement expenses; yet the pros should not be avoided.
Following are some of the concerns associated with retirement annuities.
- Heavy Fees
The main concern with retirement annuities is their heavy cost compared with CDs and mutual funds. Many are usually sold via agents, whose commission a person has to pay through a substantial upfront sales fee. Directly sold products bought directly from the insurer can help you avoid that big upfront fee.
However, you could still have to bear the annual expenses, usually above 2%. That is high even for an actively managed mutual fund. And if you have special riders to boost your coverage, you’ll end up paying more.
- Liquidity Issue
Another concern related to the annuity is its low liquidity. Many annuities bear a surrender fee, which is to be incurred if you try to have a withdrawal in the first few years of your contract. Usually, the surrender time frame is between six and eight years, although they’re often even longer in some cases. These charges can be on the large side, so it’s tough to back out of a contract once it is signed.
- Higher Tax Rates
Issuers often mention the tax-deferred position of your interest as well as investment gains as a key selling point. However, at the time of taking withdrawals, any net returns you got are taxed as ordinary income. Based on your tax bracket, that could be much more than the capital gains tax rate. If you’re young, you’ll perhaps be better offer maximizing your 401(k) plan or individual retirement account (IRA) before putting funds into a variable annuity.
One of the basic rules of investing is not to purchase or invest in a product you don’t have enough understanding about. Annuities follow the same rule. The insurance market has blasted over the last few years with a slew of new, even exotic disparities on the annuity. Some, like the equity-indexed annuity, bring the fees and limitations so intricate that only a few investors completely understand what they are indulging in.
If a person needs an annuity and is fine to bear the stock market fluctuations, he/she can go for variable annuities that offer returns based on the investment portfolio performance. Though, keep in mind that variable annuities carry costs and fees that fixed annuities don’t. Hence, consider the benefits and downsides before deciding which annuity to go for your retirement.
You can design your annuity’s payment structure in terms of the number of payments and payout duration. You can also specify the beneficiary’s name who would receive the annuity in case of your death. This structure is called a period certain option. You can also opt for a joint annuity that pays out to your inheritors in case of the death of you and your spouse.