If you’d retired, or were planning to, around 2008 you probably found yourself in big trouble. When the stock market crashed, many people saw their hard-earned retirement nest eggs lose 35 to 40 percent of their value in what seemed like a blink of the eye. Ouch. For those nearing retirement age, that meant a serious revision of their retirement plan and serious doubts about the 4-percent withdrawal rule.
This rule, which was believed to be fail-safe for years, claims that withdrawing 4 percent of your savings during the first year of retirement and increasing that dollar amount by 3 percent in each subsequent year to keep up with inflation would prevent you from running out of money for 30 years. Now, even the seemingly conservative 4-percent withdrawal rule is probably too risky. Is the dream of “guaranteed income for life” just a dream? Maybe not.
One solution is to work longer, or you can significantly scale back your lifestyle in retirement and make do with less. Another solution? Consider supplementing your retirement savings portfolio with an annuity. Since 2008, more and more financial experts are praising annuities, combined with a well-diversified portfolio, as possibly the best strategy to hedge longevity. (And since women live longer than men, that’s a particular concern for us.)
An annuity is a contract between you and an insurance company that can provide you with a reliable income stream for a certain period of time in exchange for a lump-sum investment or series of investments.
There are three main types of annuities: fixed, indexed, and variable. Depending on your timing and income needs, you may choose an immediate annuity, which begins paying income ASAP, or a deferred annuity, which gives you the ability to grow your investment account and income potential.
In a fixed annuity, you get a guaranteed rate of return based on current interest rates and periodic payments in a fixed amount based on your account value at the time you decide to receive income. These payments can last a certain amount of time, like 20 years, or for life or the lives of you and your spouse. The longer the payments are set to last, the lesser the payment amount will be.
An indexed annuity gives you the chance of earning a greater return than a fixed annuity typically based on the performance of the S&P 500 Index. However, that greater return is capped and is usually no more than 8%. Indexed annuities also guarantee a minimum contract value, regardless of index performance.
A variable annuity gives you the option of investing your payments in the market (typically mutual funds) and earning an unlimited return. However, you can also lose money based on how your investments perform, and just as your rate of return varies, your income will as well.
Annuities often include a death benefit and a variety of other optional features, for added fees. Variable annuities offer “living benefits” that can include protecting your account from losing value, guaranteeing your minimum payment, and allowing large withdrawals without penalty (many annuities come with a "surrender period" during which you would have to pay a penalty fee to withdraw your money). The more features you get in a contract, the more you will pay in fees that will reduce your account performance.
For someone in retirement or close to it, an immediate annuity could be a smart way to protect yourself from outliving your money and from market risk. Just keep in mind that choosing an immediate annuity means giving up control of your investment, so you need to be prepared to make that sacrifice.
If you’re at least 10 years away from retirement, a variable annuity could make sense, but only if you are in the small minority of people maxing out all other tax-deferred retirement plans. While annuities in general are complex products and require thorough research and education, variable annuities tend to be the most confusing and fee-heavy.
Unfortunately, annuities have a history of being sold by agents who are eager to make big commissions and do not explain them as well as they should and disclose all of the restrictions and costs upfront. So make sure you do your homework, shop around, and ask lots of questions!
Bottom line: In today’s world of disappearing company pensions, questionable Social Security and market volatility, annuities are powerful tools that should be seriously considered as part of anyone’s retirement plan. With the proper due diligence, an annuity can make the dream of guaranteed income for life a reality.
- Retirement Benefits
- Personal Finance - Career & Education