Editor's Note: This story originally appeared on NewRetirement.
Depending on whom you talk to, you’ll get very different answers to the question, “Should I purchase an annuity?” In fact, in the right circumstances, there are some great reasons to buy an annuity. However, there are also significant reasons to walk away.
The truth of course depends on your own goals, values, attitudes, and finances.
What Is an Annuity?
When you purchase an annuity, you are exchanging a lump sum of money for a monthly paycheck.
Your monthly paycheck is based on your age and interest rates at the time it is set up. Not all annuities are the same, and you should know the differences between each and make sure they align with your goals.
Annuity Options to Know
Fixed or Variable: You have two income stream options: 1) Variable — the amount you get varies each month along with interest rates or investment returns. Or 2) The income stream can be fixed — the amount you get remains the same no matter what is going on with the financial markets.
Term or Lifetime: You can buy income for a specific period of time (term) or income that will last as long as the policyholder(s) live(s).
Immediate or Deferred: Your income can start immediately or at some point in the future. Deferred annuities are one of the creative ways some people plan for a long-term care need.
Survivor Benefits: When you buy a lifetime annuity, you can guarantee your income for your own lifetime and/or that of your spouse or even other dependents.
Inflation Protection: You can opt to have your annuity income be guaranteed to keep pace with inflation or grow at a preset rate.
Principal Protection: You can even guarantee that you will get at least as much money back from your annuity as you originally put in.
So, is an annuity purchase right for you? Let’s explore reasons why you might want an annuity and reasons why you are better off with another option for your money.
4 Reasons to Purchase an Annuity
First up are four reasons to consider adding an annuity to your retirement portfolio.
No. 1: With a lifetime annuity, your income will last as long as you do
With a lifetime annuity, you are guaranteed periodic payments for as long as you live. The “risk” of you living a long and happy life is borne by the insurance company providing the annuity. Your income will last as long as you do.
One of the biggest fears of retirees or people nearing retirement is anxiety about running out of money. Annuities are appealing to retirees because they transform your savings into predictable income.
No. 2: You want an efficient way to plan for long-term care needs
If you opt for a deferred lifetime annuity — an annuity that starts at a specified date in the future and then pays for life thereafter — you have a reasonable way to plan for funding long-term care — should you require it.
If you don’t need long-term care, then you get a bump in income at your annuity start date.
No. 3: You understand how an annuity fits into overall asset and income strategies
In retirement, you want to increase your money while also spending it. You have numerous competing financial priorities. You want to:
- Grow your money — or at least outpace inflation.
- Protect your assets so that they are there when you need them.
- Efficiently turn your savings into income — in a way that covers whatever future expenses you encounter.
- Plan for leaving behind something for heirs.
A good way to achieve these competing goals is to develop an asset allocation strategy. Many times a retirement asset allocation strategy involves having your money in different “buckets” with each bucket invested for different goals.
- Assets serving short-term or necessary spending might be in low-risk (low return) vehicles, like cash, bonds, TIPS, or annuities.
- Other money serving longer-term or flexible spending can be invested in riskier (higher return) asset classes like stocks or funds.
Learn more about bucket strategies for retirement.
No. 4: Annuities may reduce stress
While there may be many financial reasons to consider buying an annuity now, perhaps the best reason of all is that an annuity may make you happier.
According to a Towers Watson Retirement Survey, having predictable retirement income (presumably adequate income to cover all of your expenses) can help you feel happier.
Conversely, the researchers discovered that retirees who must withdraw money from investments to pay for retirement expenses had the highest financial anxiety. The stress of managing investments and worrying about losing your money to the financial markets is greatly reduced when you buy an annuity. You are guaranteed the agreed-upon paycheck no matter if the stock market declines or not.
4 Reasons to Walk Away From an Annuity
Despite the many advantages of annuities, they do have some downsides.
No. 1: Annuities lack flexibility
Annuities are not as flexible as other investment options — once you purchase an annuity contract, your money is tied up in the annuity.
And, some retirement financial planners recommend that people reserve at least 40% of their retirement assets for unforeseen circumstances. Because most annuities are designed to provide steady income over time, they are not ideally suited to cover large unplanned expenses.
No. 2: They can be confusing and complicated
Many financial planners view some annuities — particularly fixed annuities — as being the ideal solution to a retiree’s need for guaranteed income. Fixed annuities have a very good reputation. However, other annuity products are viewed as “snake oil” — an unnecessary and expensive product.
It is very important that you understand the various features and terms that are applied to annuities.
No. 3: Giving up investment upside
A fixed annuity is considered to be a safe and conservative investment. This means that you will not see the possible gains (and losses) of a riskier investment — such as the stock market.
No. 4: High costs
Sales commissions and management fees are common complaints about annuities. And, sometimes costs are definitely too high. When purchasing an annuity, it is recommended that you shop around and really know exactly what you are paying for.
So, Should I Purchase an Annuity?
In many cases, the answer to the question, “Should I purchase an annuity?” is an emotional — not necessarily a financial — response.
You might be giving up the upside with your money invested in an annuity. However, you might feel better and more at ease.
Here are a few steps to take if you are considering an annuity. Use the NewRetirement Planner to:
- Figure out if there is a gap between your retirement income from guaranteed sources (Social Security and pensions) and your expenses — and exactly how big that gap is and how it might change over time.
- Determine what an annuity to cover that gap would cost.
- If you were to purchase an annuity to fill the gap, would you have sufficient assets left over to cover unforeseen expenses?
- Compare purchasing an annuity to other options for your money.
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