Using Annuities for Retirement Planning: Maximize Income and Protect Savings
Retirement planning is a critical part of financial planning. It’s the point at which people leave behind a career and enjoy the fruits of their life’s work. Since they are no longer bringing home the bacon from their job or business, the money has to come from somewhere.
To that end, ensuring a secure and stable income during retirement is a top priority. While there are a variety of financial vehicles that you can tap for income, annuities are an effective way to maximize retirement income.
With their contractual guarantees, they offer a unique way to provide a steady stream of income throughout retirement, helping retirees maintain their lifestyle and meet their financial needs. The risk tied to annuity payouts is pooled by insurance companies across thousands of contract holders, creating efficient risk management that no individual retirees can produce by themselves.
In this article, we will cover using annuities for retirement planning, their benefits, and some reasons for including them as part of a comprehensive retirement plan. Before going further, let’s cover the basics of annuities.
What Are Annuities?
Annuities are contracts offered by insurance companies that are designed to pay a regular income stream to someone. The insurance company makes this promise in exchange for a lump-sum payment or a series of payments from the contract holder.
They are classified into various types: fixed, variable, fixed index, multi-year guarantee, and immediate annuities. Each kind offers distinct features and benefits.
Immediate Annuities
Immediate annuities are started with a single lump-sum premium, and the income payments begin almost immediately. In many cases, the first payments are within 30 days of the contract start date.
Immediate annuities are also known as “single premium immediate annuities,” or SPIAs for short. They are a good option for those seeking an immediate and predictable income stream during retirement. In today’s market, immediate annuities come in both fixed and variable flavors, depending on what someone prefers for risk and market exposure.
Fixed Annuities
Fixed annuities offer a guaranteed rate of growth, and the insurance company assumes the investment risk. This guaranteed rate is good for a certain period, then the insurance company renews this rate at a higher or lower level.
The longer the guaranteed period, the higher the growth rate tends to be, as you are making a longer-term commitment with a longer contract duration. As the insurance company sets the guaranteed rate whenever the contract period is over, there is “renewal rate risk,” or the chances that the new guaranteed rate will be lower than the original.
You can avoid this risk by opting for a longer traditional fixed annuity or for a close annuity cousin that guarantees the rate for a longer period, called a multi-year guarantee annuity (more on that later). Just like with all annuities, a fixed annuity can pay a guaranteed income stream. However, most annuity owners have this kind of annuity for the interest earnings.
Variable Annuities
On the other hand, variable annuities offer a more flexible approach to investing. The premiums paid by someone are invested in a range of subaccounts, which are similar to mutual funds.
In other words, the annuity owner holds the investment risk, and the value of the money inside the annuity can change based on the performance of the underlying investments. Variable annuities may appeal to those seeking potential higher growth potential but are willing to stomach market risks.
Variable annuities can pay a guaranteed income stream, although some have an add-on rider benefit that lets your income benefit grow at a guaranteed rate. Other variable annuities can have the income fluctuate depending on how the subaccounts perform. You may want to check with your financial professional if that is an important factor for you.
Fixed Index Annuities
Fixed index annuities are almost like a happy medium between fixed and variable annuities. The annuity’s growth potential is linked to an underlying benchmark market index, such as the S&P 500 price index.
Fixed index annuities can earn interest based on a portion of index gains while also protecting the principal against market downturns. In exchange for this protection, the growth potential can be limited by insurance companies with caps, participation rates, or spreads.
Benefits of Using Annuities for Retirement Income
There are a variety of advantages to using annuities as part of an overall retirement income strategy. Let’s cover them now in depth.
Lifetime Income
One of the biggest advantages of annuities is their ability to offer guaranteed lifetime income. This means that once the income payments begin, they will continue for as long as someone lives, regardless of how long that may be.
This feature provides a crucial guard against longevity risk, arguably one of the hardest-to-predict risks in retirement. That helps ensure that retirees won’t outlive their savings.
Stability and Predictability
All annuities can offer a guaranteed income, but fixed annuities and fixed index annuities in particular can offer more stability and predictability in a retirement income stream. This is due to the principal protection feature of these contracts, and also how the annuity payments can grow over time before they are turned on.
Retirees can count on a pre-determined payout amount, which allows for easier budgeting and planning during retirement. They can also count on this income stream for years or even decades, depending on how long they expect that retirement might last.
Tax-Advantaged Growth
Annuities offer certain tax advantages. Just like money within a qualified retirement account, such as an IRA or 401(k), money inside an annuity has special tax treatment. The annuity’s earnings are tax-deferred until withdrawal. This can be beneficial for building up more retirement assets over time, but keep in mind that you will pay income tax on your withdrawals.
Diversification of Retirement Income
Adding an annuity to a retirement income strategy can provide diversification. Annuities complement other sources of retirement income, such as Social Security and pensions, by creating a separate income stream.
Diversification can help reduce the impact of market volatility on overall retirement income.
Estate Planning
Annuities can also be used as part of an estate planning strategy. With certain annuity options, such as a joint and survivor annuity, income payments can continue to a surviving spouse or beneficiary even after the annuitant’s passing.
This ensures ongoing financial support for loved ones. It can be particularly valuable for couples concerned about the financial security of a surviving spouse.
Considerations for Incorporating Annuities into Retirement Planning
While annuities offer many benefits as a retirement income strategy, they aren’t right for everyone. Consider the following factors before you commit to including annuities in your retirement plan:
Financial Goals and Risk Tolerance
Retirees must assess their financial goals and risk tolerance when choosing an annuity. For risk-averse individuals seeking stable income and protection against market volatility, a fixed or fixed indexed annuity may be more appropriate.
On the other hand, those comfortable with market fluctuations and seeking potential higher growth potential might consider a variable annuity. Talk to your financial professional to see what might make sense for your situation and goals.
Understanding Fees and Expenses
Annuities can come with fees or charges, though this is typically tied to the annuity kind. For example, variable annuities often come with various fees and expenses, such as administrative fees, and mortality and expense charges.
Annuities also have surrender charges for early withdrawals. If you have long-term goals for which the annuity helps solve, then many annuity owners would say that the commitment is worthwhile.
It’s important to understand any costs tied to your annuity and how they impact your contract, benefits, features, or other details.
Liquidity and Access to Funds
Annuities typically have limited liquidity, especially during the surrender period. However, they do tend to have provisions for “free withdrawals,” or where you can take up to 10% of the contract per year without penalty.
Withdrawing excess funds above that level prematurely may result in penalties. Therefore, it’s crucial to make sure that people have sufficient liquid assets outside of annuities to cover emergency expenses and unexpected financial needs.
Inflation Protection
Annuities can help your income keep up with inflation… to a fault. But it’s best for them to work with other holdings in a comprehensive retirement portfolio so that you have financial vehicles with market risk, but higher growth potential than what fixed-type annuities can offer. That can help your money keep up with inflation overall.
What’s more, some annuities offer inflation-adjusted options or other increasing payment options. Alternatively, retirees may choose to create a diversified retirement income plan that includes investments with potential for growth to counteract inflation.
Annuity Creditor Protection
The level of creditor protection for annuities varies depending on state laws. In some cases, annuities may offer additional protection against creditors, which can be a nice boon for asset protection strategies.
The Bottom Line on Annuities and Retirement Planning
Annuities can be a valuable tool in retirement planning, offering guaranteed lifetime income, stability, and tax advantages. By providing a steady stream of income, annuities can help retirees maintain their desired lifestyle and keep up financial security.
However, it’s essential to carefully consider individual financial goals, risk tolerance, fees, and liquidity needs before incorporating annuities into a comprehensive retirement plan. Working with an experienced financial professional can help people make well-informed decisions and explore an annuity strategy that matches up with their personal situations and retirement objectives.
If you are looking for someone to help you with your questions about retirement, many independent and knowledgeable financial professionals can assist you here at SafeMoney.com. Get started by visiting our “Find a Financial Professional” section, where you can connect with someone and request an initial appointment to discuss your goals, concerns, and personal situation. If you would like a personal referral, please call us at 877.476.9723.
