Creating income for retirement is one of the biggest challenges American workers have in planning for how they will be able to live comfortably once they stop working. One of the most common ways to create this income is to buy yourself an annuity. New research from investment analysis firm Morningstar, though, shows that if you’ve managed to save a sufficient amount of money during your working years, an annuity isn’t actually the best choice for you.
If you want help determining the best course of action for your own retirement, consider working with a financial advisor.
Annuity Basics
Annuities are not the simplest investment to understand, so let’s start off with a bit of a crash course in what they are and how they work.
Essentially, an annuity is an insurance contract. You pay an insurance company a monthly premium now, and in return, you get a payout at a later date. There are two basic types of annuities — fixed and variable. A fixed annuity has a predetermined payout and the performance of the premiums you pay in the market doesn’t have any impact. A variable annuity, on the other hand, will have a payout that depends on how the investments made with your premiums perform. There will generally be a minimum payment that guarantees you don’t lose your principal, but it’s possible that the money won’t grow at all, which is not a concern with a fixed annuity.
When it comes time to collect your money, you will often have the choice of a lump sum or annuitized payments. Some annuities pay out until death while some only pay for a predetermined length of time. All of this is determined when you buy your annuity contact.
Who Should and Shouldn’t Use Annuities?
When you retire, the amount of money you have coming in each month will likely go down drastically. Depending on your age, you may have Social Security payments, and some may have pension payments, but for the most part you won’t have income being deposited into your bank account like you did when you were working. Annuities seek to remedy that.
If you’ve saved enough money while you are working, though, an annuity may actually not be a good choice, according to a recent report from Morningstar:
“In particular, if a participant’s wealth is more than 36 times their needed annual retirement income (defined as the difference between annual deterministic expenses and Social Security income), there is little room for an annuity to meaningfully impact their retirement,” the report reads. “This is because higher-wealth participants can more or less self-insure against longevity risk”
According to Morningstar’s calculations, someone with 36 times his needed annual retirement income saved will succeed in funding his retirement soundly 95% of the time with a portfolio-only strategy. That percentage only ticks up to 95.9% if you use an annuity, not enough of a difference to justify using an annuity.
The report notes that annuities are also not the best option for those who have enough income through a combination of an inflation-adjusted pension and Social Security.
Social Security Bridge – Another Option
Morningstar also details an alternative plan for making sure you have enough money in retirement without having to buy an annuity, a strategy known as the Social Security Bridge.
Here’s how it works: when you retire, don’t immediately file to get Social Security benefits. Instead, take a bigger portion of your retirement savings than you’d normally take in the first several years after you stop working.
When you turn 70, you file for Social Security. By waiting until that age, you actually get significantly higher payments — more than 40%, according to the report. Once you start taking these payments, you can reduce the amount of money you take out of your retirement accounts each year.
The Bottom Line
Annuities are useful tools for retirement saving, allowing you to create guaranteed income after you retire. Morningstar analysis, though, shows that if you have at least 36 times your needed annual income saved at the time of retirement, you likely don’t need to get an annuity.
Retirement Planning Tips
The best way to go about planning your retirement is often to get professional help. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Saving in a 401(k) is how most people accumulate money for retirement. If your company offers an employer match program, make sure you take advantage and not leave any money on the table.
Morningstar analysis, though, shows that if you have at least 36 times your needed annual income saved at the time of retirement, you likely don't need to get an annuity. The best way to go about planning your retirement is often to get professional help. Finding a qualified financial advisor doesn't have to be hard.
Annuities can provide a reliable income stream in retirement, but if you die too soon, you may not get your money's worth. Annuities often have high fees compared to mutual funds and other investments. You can customize an annuity to fit your needs, but you'll usually have to pay more or accept a lower monthly income.
You should not buy an annuity if Social Security or pension benefits cover all of your regular expenses, you're in below average health, or you are seeking high risk in your investments.
A $100,000 immediate income annuity purchased at age 65 could provide around $614 per month. With a 5% interest rate and a 10-year payout period, the same annuity might pay approximately $1,055 monthly. At age 70, a similar annuity could offer a lifetime payout of around $613 per month.
A straight fixed annuity is the easiest type of annuity to calculate a payment from. This is because fixed annuities work like bonds. If you use $50,000 to buy a fixed annuity paying 5% per year, for example, you'll earn $2,500 annually or about $208.33 per month.
Orman states that SPIAs can therefore take the place of CDs or treasury notes to help provide income in retirement. Many people think that Suze Orman "hates annuities," but she concedes there are circ*mstances where they do make sense.
“The very wealthy probably don't need annuities,” Rob Williams, managing director at the Schwab Center for Financial Research, told Annuity.org. “They may have enough money just to support their retirement without needing to buy annuities. Annuities are a form of insurance.”
Annuities can be a bad choice for some people—they have higher fees and less flexibility than some savings options. And depending on the type you choose, your heirs may get nothing after you die even if far less was paid out than you had contributed.
In general, 401(k) plans — and the very similar 403(b) plans offered by nonprofit organizations — are a better way to grow your cash for retirement than an annuity.
The key advantage of purchasing an annuity at 70 is the guarantee of a steady income stream. An annuity is an insurance policy designed to provide a consistent flow of payments, unaffected by market fluctuations. This guarantees financial certainty for many retirees.
According to Blueprint Income, the average monthly payouts for men aged 60 to 75 investing in a $200,000 annuity could range from about $14,000 to $20,000 per year — $1,167 to $1,667 per month. For women, however, those rates drop to a range of $13,710 to $19,076, or $1,143 to $1,590 monthly.
Because annuities grow tax-deferred, you do not owe income taxes until you withdraw money or begin receiving payments. Upon withdrawal, the money will be taxed as income if you purchased the annuity with pre-tax funds. You'll only owe taxes on the annuity's gains if it was purchased with post-tax dollars.
You (or your beneficiaries) will generally get your money back because the insurance company is not basing the payments on your life expectancy. Instead, they know they need to pay it all back over a certain number of years, and they'll earn a profit while holding your funds.
That comes to about $5,167 per month. Waiting to take payments could increase the amount you receive every month from a $1 million annuity. For instance, if you sign a contract when you are 60 years old and begin payments five years later, “your annual payout will be approximately $90,000 at age 65,” Coffman says.
So, if you have experience and success managing your funds on your own and can convert your assets into an income, there is no reason to buy an annuity. 2. Don't buy an annuity if you're sure you have enough money to meet your income needs during retirement (no matter how long you may live).
If you're in your 30s and 40s, absolutely early 40s, just do not buy an annuity. Going back to that 50 1/2 Rule, if you buy a Deferred Annuity like a Multi-Year Guarantee Annuity or a Fixed Index Annuity, if you take money out before you're 59 1/2, there's a 10% IRS penalty on that money you're taking out.
An annuity is a way to supplement your income in retirement. For some people, an annuity is a good option because it can provide regular payments, tax benefits and a potential death benefit.
Introduction: My name is Terrell Hackett, I am a gleaming, brainy, courageous, helpful, healthy, cooperative, graceful person who loves writing and wants to share my knowledge and understanding with you.
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