This Bad Buzz Financial Product May Be Good for Your Retirement
Why the right annuity can yield financial and emotional benefits
(This article previously appeared on RealDealRetirement.com.)
Can an investment that’s routinely reviled in the media and disdained by many financial advisers improve your retirement prospects and make for a more enjoyable retirement? The answer, as with many questions in life, is more complicated than a simple yes or no.
Annuities often get rough treatment by the financial press, in many cases well deserved. As a recent report on annuity marketing practices by Senator Elizabeth Warren described in disturbing detail, many annuities are sold to investors in ways that may lead salespeople to put their interests ahead of their clients’.
And some versions of annuities, such as indexed annuities, can be so complicated that you practically need to be a finance wiz to figure out how they work and how they might perform.
Then there are the often onerous fees, which, in the case of variable annuities with lifetime income riders, can sometimes total upwards of 3 percent a year.
The Benefits of Annuities
And yet, a wide body of research also shows that making an annuity a part of your retirement income plan can yield some major financial and emotional benefits.
For example, in a paper published by the George Mason University’s Mercatus Center, former U.S. Treasury Department official Mark Warshawsky showed that certain income annuities can often generate more inflation-adjusted retirement income than one might get by following the 4 percent rule or a similar program of systematic withdrawals from a portfolio of stocks and bonds.
Similarly, recent research from Employee Benefit Research Institute economist Jack VanDerhei suggests that many boomers and GenX’ers may be able to boost their retirement prospects by putting a portion of their savings into a type of annuity that doesn’t begin making payouts until the later stages of retirement.
And then there’s the evidence that, potential financial plusses aside, the guaranteed income that annuities provide can make for a more satisfying retirement.
According to a TIAA-CREF Institute survey, people who converted at least some of their retirement savings into annuity payments guaranteed for life were about 60 percent more likely than those who didn’t invest in an annuity to say their standard of living increased in retirement and that their post-career lifestyle exceeded their expectations.
A 2012 Towers Watson report titled Annuities and Retirement Happiness also cited a connection between guaranteed income and a happier retirement, in this case noting that retirees who received guaranteed income in the form of a traditional check-a-month pension or annuities tended to have higher retirement satisfaction scores than those without such income.
How to Limit the Downsides
Which leads to a logical question: Is it possible to get the benefits annuities can offer while mitigating downsides like mind-numbing complexity, bloated fees and conflicts of interest?
I believe the answer is largely yes.
But before I get to how to make that happen, I want to stress that just because annuities can often play a legitimate role in a retirement income plan, that doesn’t mean an annuity is automatically right for you.
If your retirement nest egg is so large that your chances of running through it in your lifetime are minuscule, then you probably don’t need an annuity. Warren Buffett will make it through retirement quite nicely without one.
Similarly, if Social Security will cover all or most of your essential living expenses, then you can likely get the retirement income you need from Social Security plus periodic withdrawals from savings.
And if you just prefer to invest your savings and manage withdrawals on your own, then you’re probably not a candidate for an annuity.
But if you like the idea of getting more guaranteed lifetime income than Social Security and any pensions alone will provide — or you want additional assurance that you’ll have income flowing in no matter how long you live regardless of how the market performs, then the question becomes: What type of annuity can best help you meet your goal?
On that score, I contend you’re better off passing on complicated annuities that offer lots of bells and whistles (which usually means higher sales commissions and other fees) and sticking instead to plain-vanilla options that do what annuities do best — generate guaranteed income you can’t outlive.
Immediate Annuities and Longevity Annuities
And the two types of annuities that do that best, in my opinion, are immediate annuities and longevity annuities.
The premise behind an immediate annuity is simple: you give an insurer a lump sum in return for monthly payments that start at once and continue the rest of your life.
A 65-year-old man who invests $100,000 in an immediate annuity today would receive about $555 a month for life; a 65-year-old woman would collect roughly $530 a month; and, 65-year-old couple (man and woman) would receive about $475 a month as long as either one is still alive.
A longevity annuity also provides lifetime income, but with this twist: Even though you pay the premium now, you don’t start collecting payments until later, usually much later, say, 10 to 20 years down the road.
The idea is that by postponing payments, you can put up less money today (thus leaving more of your savings available for current spending) while still ensuring you’ll have money coming in later in retirement, even if you overspend early on.
A 65-year-old man who invests $30,000 in a longevity annuity today that begins making payments 15 years from now would receive roughly $675 a month at age 80 that would continue for the rest of his life; a 65-year-old woman would receive about $575 a month starting at 80; and, a 65-year-old couple would collect about $465 a month beginning at age 80 for as long as either remained alive.
If you buy a longevity annuity within an IRA, 401(k) or similar retirement account, you’ll want to be sure it’s been designated a QLAC, or Qualified Longevity Annuity Contract, and that you limit your investment to the lesser of $125,000 or 25% of your account value.
Questions and Tips Before Buying
Finally, even if you decide you are a candidate for an annuity, don’t rush into one (or let a salesperson pressure you into investing). Make sure that you understand the annuity’s downsides as well as steps you may be able to take to mitigate them.
Devoting a portion of your retirement to the right type of annuity may or may not be a good move. But you should base your decision on whether it makes sense for you, not just on what others have to say about annuities, pro or con.