Finances

The Financial Investment You May Be Overlooking that Can Help Secure Your Retirement

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Are annuities worth it for retirement?

By Vittorio Mena, OD, MS

July 31, 2024

As we grow older and get closer to retirement, we need to find a reliable income stream. The biggest unknown is whether we will outlive our money.

Annuities can help provide an ongoing income stream after retirement. An annuity is a financial product that acts as a contract with an insurance company, and pays out money for life.

There is a common perception that annuities are ploys used by agents/brokers to prey on consumers.

Contrary to popular belief, however, annuities can be part of the picture that brings you to a more secure retirement.

Creating a “Personal Pension”

Financial planning is an art, and since fewer people are retiring with pensions—a guaranteed income for life that many companies used to give their employers—it is time to come up with a game plan.

The Federal Reserve showed that “22 percent of workers are currently covered by a pension”.1 Life insurance protects you for your early years, but for later years, an annuity (a personal pension) can help you avoid outliving your retirement money.

Studies have shown that “among people retired 10 years or more, those with annuitized income are 43 percent more likely to consider themselves ‘very satisfied’ than those without and also 39 percent less likely to report four or more symptoms of depression.”2

To maximize the advantages of annuities, they have to be in the right amount and for the right person, typically for those who are entering retirement, and you need certain annuity calculations to be done to refine your plan. The factors that must be considered include your income, expenses and retirement portfolio.

The Annuities You Have to Choose From

Let’s take a dive and see the differences and the pros and cons of this financial vehicle.

Immediate Annuity: Guarantees income for life or a set amount of time and can pay out potentially 7 percent, or more, annually of your initial investment. Typically, you want to put in less than 50 percent of your net worth since you cannot access your principal. You will get the same amount each year, but, due to inflation, you will effectively receive less the older you get. The payout amounts for an immediate annuity can vary by company. Payouts may be made monthly, quarterly, semiannually or annually.

Deferred Annuities: Long-term contract with tax deferred growth (can choose the length of years or decades)

      a. Fixed: Pays a guaranteed interest rate on your savings (Example 6, 7 or 8 percent based on how the S&P 500 is doing) with no loss of money during down markets.

      b. Variable Annuities With Living Benefits: Guarantees money for the rest of your life even if the market takes a hit and money is invested in mutual funds. The money is invested in stocks and bonds, and your minimum guarantee rises if your investment increases.

If your investment grows faster than your withdrawals, your annual payouts can rise. But if your investments take a dive, you are still guaranteed the minimum payout you locked in. Variable annuities can also be attractive to people in their late fifties or early sixties who plan to retire in a few years and worry about a big market drop just as they are about to start taking withdrawals. They want to keep money in the stock market for future growth, but they also want to lock in a guarantee now.

      c. Indexed: An equity-indexed annuity mixes the features of variable and fixed annuities, providing a guaranteed minimum payment that could increase if the annuitant’s investments outperform.

Qualified Longevity Annuity: Start paying out at around 85 years old or older. For example, if a 65-year-old person invests $50,000, they get back $35,205 a year in monthly payments starting at 85 for the rest of their life.

As with social security, the longer you wait to receive payments, the higher the payments will be. It is recommended to invest no more than 10 percent of your portfolio in longevity insurance, so that you will have plenty of money for other needs.

Pros & Cons of Annuities

Pros:

  1. Guaranteed income during retirement (Peace of mind)
  2. Another tax deferred growth vehicle (Pay income taxes on earnings)
  3. Safe returns (Growth while preventing market losses)
  4. Stability from risk pooling (Can benefit from mortality credits)
  5. Extra rider benefits (Ex: Long-term care or cost of living adjustment)

Cons:

  1. Early withdrawal tax penalty (Locked up until 59 1/2, if take out before then pay income tax plus a 10 percent penalty on the gains)
  2. Surrender charges and taxes (However disappears after year 7)
  3. High fees (The more riders you have the more it costs; however fixed and income annuities have few or no fees at all; Variable annuities tend to have higher fees)
  4. Inflation (If one does not add a cost-of-living adjustment rider to increase pay, you will get the same amount every year as inflation goes up)
  5. Limited liquidity (This is why it is important to have an emergency fund so that you have access to money when you need it)

Remember, all annuities are not created equal. You would need to speak with a financial planner to find the best fit for your specific situation. Always remember to read the prospectuses and compare the fees, surrender charges and specific guarantees.

Disclaimer: This is for informational purposes only and is not intended to be personal advice, and there is always risk involved with any type of financial decision.

References:

  1. https://www.federalreserve.gov/publications/2023-economic-well-being-of-us-households-in-2022-retirement-investments.htm
  2. https://www.tiaa.org/public/plansponsors/insights/tmrw/edition-2/retirement-happiness-factors-and-annuities-benefits

Vittorio Mena OD, MS, is the sports vision director with Optical Academy. Dr. Mena is also an Optometric Financial Planner, with Series 6 and 63 investment licenses and Series 2-14 life and variable annuity licenses. To contact him: menavitt@gmail.com

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