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January 14, 2015
Retirement Planning… It can be confusing and rough (ruff?)
Investments are hugely important for retirement planning. “Investing” means putting money into an asset with the expectation that it will grow, produce dividends or generate interest. Investments are designed to grow your money although most, if not all, forms of investment involve some form of risk.
By this definition, annuities are a terrible investment. Why? Below the experts weigh in with three reasons:
1) Most Annuities Have No Promise of Financial Growth (Even Though You Might Get Out More Than You Put In)
Unlike other financial products, most annuities do not provide returns — they shouldn’t really even be thought of as investments.
“It’s not an investment account, it’s not liquid and your return is based entirely on how long you live and when you die,” says Michael Kitces, partner and director of research at Pinnacle Advisory Group in Columbia, Md.. “The value of a lifetime annuity does not go up and down based on what the market does; it goes up and down based on how long you live.”
For example, if you put $100,000 in a lifetime annuity and receive $500 a month for life, after 10 years you have only gotten $60,000 out of your annuity. But if you live for 20 years, you’ll get $120,000 out of your annuity. Beyond that, if you live for 30 years, you’ll get $180,000; and after 40 years, you will have gotten $240,000 from your annuity.
“If you want to view it as an investment, a lifetime annuity is an investment that pays you a higher return the longer you live,” Kitces says, noting that they still shouldn’t be considered as such.
2) Your Money is Not Liquid — Many Fear ‘Tying Up Their Money’ in Annuities
Liquidity is often a concern for many older Americans nearing retirement: If I need my money, will I be able to access it? What if I die before my annuity begins payments?
These are valid concerns, and represent the third reason annuities should not be considered as investments, but as retirement insurance.
You should never put all of your assets into an annuity, Kitces says.
“Life happens — medical events, house repairs, things that come up that you can’t pay for with a steady paycheck — so you definitely have to be wary of annuitizing everything into guaranteed income.”
Although you can usually still withdraw money from an annuity, it comes with a price. Withdrawals taken before age 59½ may be subject to a 10% IRS penalty tax unless an exception applies, according to Ameriprise Financial. So early withdrawals are costly from a tax standpoint.
3) Lifetime Annuities are Not Designed as Investments
Lifetime annuities are designed to guarantee income for life, not to produce asset growth.
So many people are conditioned to think that money must be “invested” to produce interest, returns or dividends. However, there are other types of financial products that can produce other — and often desirable — results.
By definition, an annuity is an insurance product that pays out income. You provide a lump sum to the insurance company, which then makes payments to you for life (in the case of lifetime annuities). Instead putting your money into a financial vehicle and hoping for a return on the investment (as you would when buying a mutual fund for example), you are putting your money into a financial vehicle that guarantees you a pre set amount of income for as long as you live.
Because lifetime annuities are structured as a guarantee, with little risk involved, classifying them as “investments” is inaccurate.
“They’re not investments; they’re transfer-of-risk products,” says Stan Haithcock, an annuity expert who goes by Stan the Annuity Man. “You buy an annuity for peace of mind.”
While annuities are used for a number of reasons, about half (49%) of Americans indicate they would purchase one to secure a predictable source of monthly income for retirement, according to a 2014 Phoenix Companies survey.
“From the pure goal of trying to generate retirement income, lifetime annuities are rather efficient,” says Kitces. “When you’re trying to solve the challenge of retirement income, it’s really the perfect vehicle.”
Why Should Lifetime Annuities Be Used for Retirement?
For the reasons stated above, lifetime annuities are a terrible “investment.” However, they can be a great financial decision for your retirement because they are designed to remove risk from the financial planning equation.
“Lifetime” annuities refer to annuities that guarantee income for life. While most people use the phrase to refer to single premium immediate annuities, they can also take other forms, says Haithcock.
“Most people who say ‘lifetime annuity’ are referring to immediate annuities,” he says. “For me, it’s a product that guarantees income for life. It could be a variety of products: It could be an immediate annuity, a longevity annuity or a deferred annuity with an income rider, [among other products].”
But these annuities are often characterized as a retirement investment, leading to further confusion and a broad misunderstanding of the product.
It comes down to the goal for your retirement assets. Do you want to achieve returns or do you want to guarantee income. Both goals have a place in a retirement plan, but you achieve them through different types of financial vehicles.
To figure out your financial goals, consider using a retirement calculator. It may also be important to first consult a financial advisor. To start the planning process, search for an advisor today.
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