Should I Buy an Annuity? 4 Reasons to Make the Purchase and 4 Reasons Not To
The truth of course depends on your own goals and finances.
What is An Annuity?
When you buy an annuity, you are exchanging a lump sum of money for a monthly paycheck.
Depending on the type of annuity (e.g., immediate, fixed, fixed-indexed or variable) monthly payments are based on your age and interest rates at the time it is set up. Not all annuities are created equally and you should know the differences between each and make sure they align with your goals.
Annuities are appealing to retirees because they transform your savings into predictable income.
Reason to Buy an Annuity #1:
Annuities Offer Flexibility and Customization
Annuities are not a one size fits all product. There are so many different options to choose from. Here are a few choices you can make:
Fixed or Variable Income: The income stream can be variable — the amount you get varies each month along with interest rates or investment returns. Or, 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 or income that will last as long as the policy holder(s) live.
With a lifetime annuity contract, 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.
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.
For retirement, most people look at a fixed lifetime income annuity with inflation protection — covering both your and your spouse’s lives.
Reason to Buy an Annuity #2:
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.
However, if you buy the right annuity for your needs and can afford to buy enough income to cover all necessary expenses, then your chances of not being able to fund your life into a very old age are greatly diminished.
Reason to Buy an Annuity #3:
Annuities Can Solve 3 Big Retirement Financial Problems
If you have managed to save enough — or nearly enough — for retirement, you still face some big retirement challenges. Three of your biggest concerns probably include:
1. Creating a steady income stream: When you retire, you need to figure out how to most effectively turn your savings into reliable income. An annuity is an increasingly popular way to do this. “Fixed income annuities may be one of the better ways to create a lifetime guaranteed stream of income for retirees,” says Jeff Bogart, a financial advisor with Sila Wealth Advisory, in Mayfield Heights, Ohio.
But there are some specific steps to take to maximize their effectiveness. “One strategy is to make sure a retiree has his/her fixed expenses covered through a combination of Social Security and an annuity,” Bogart says. “It is also recommended to start an annuity in one’s late sixties to early seventies.”
2. Gaining tax leverage: The purchase of an annuity with qualified retirement savings (401k or IRA funds) can save you money on taxes over taking a lump sum payment. You can roll-over qualified funds into a qualified annuity without any tax penalties. You only pay taxes on the income the annuity provides.
3. Reducing risk of losing money: The stress of managing investments and worrying about loosing 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.
Reason to Buy an Annuity #4:
Annuities Actually 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 predicable 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.
4 Reasons NOT to Buy an Annuity
Despite the many advantages of annuities, they do have some downsides.
Confusing and Complex: 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.
Giving Up Investment Upside: A fixed annuity is considered to be a safe and conservative investment but this means that you will not see the possible gains (and losses) of a riskier investment – like the stock market.
High Costs: Sales commissions and management fees are a common complaint 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.
After getting annuity estimates, you can connect to an annuity marketplace that helps you get up to 15 different quotes from a wide variety of insurers.
Inflexible – Annuities are not as flexible as other investment options – once you purchase an annuity contract your money is tied up in the annuity. Some retirement financial planners recommend that people reserve at least 40 percent 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.
So, How to Decide if an Annuity is Right for You?
You probably first want to know how much income you can buy with your available savings. An annuity calculator can give you fast answers.
However, it is important to consider an annuity as part of your overall retirement plan. Before purchasing an annuity, you should know 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.
You should also assess how an annuity fits into your overall retirement plan.
The NewRetirement Retirement Calculator enables you to take a detailed look at your income and expenses. And, after setting up your account, you can “try on” different scenarios and immediately see how an annuity may impact your net worth, estate and cash flow.