This was originally published on The Penny Hoarder, which helps millions of readers worldwide earn and save money by sharing unique job opportunities, personal stories, freebies and more. The Inc. 5000 ranked The Penny Hoarder as the fastest-growing private media company in the U.S. in 2017.
Why do annuity payments belong in a plan for retirement income?
There is a very simple answer: Retirees who have annuity payments feel more confident about their long-term finances in retirement.
It seems obvious to someone like me, who is an actuary by training and spent most of my later career in the retirement business. That confidence comes because an annuity payment is similar to Social Security or a pension in one important respect: They all provide a lifetime of guaranteed income.Â
Since annuity payments are guaranteed under contracts issued typically by highly rated insurance companies, in my view retirees or near-retirees with a reasonable life expectancy should at least consider them as an important source of retirement income. However, according to one survey, a relatively low percentage of retirees â fewer than 15% â make annuity payments part of their retirement income plans.
So, letâs discuss the objections and questions that consumers often have about annuity payments, the contracts that guarantee those payments, and the reasons annuity payments belong in a plan.
Today, the annuity landscape is quite competitive and often confusing to average investors. There are many types of annuities. They can be grouped in various ways:
I take some responsibility for changing the annuity landscape, having invented the first annuity that could be categorized as accumulation/variable/downside protection/future annuitized income.
Unfortunately, contracts providing guaranteed annuity payments often get lumped together with other annuities, and thatâs where the confusion creeps in. Itâs just like with insurance: Car insurance is not the same as life insurance, health insurance or dental insurance. So, you should look at each annuity based on its stated purpose and not whether it shares a name with another product. One type of annuity might be just right for you, while others might not be a good fit.
The rest of this article is about annuity contracts whose sole purpose is to provide lifetime annuity payments â starting now or at a date in the future you select. Letâs start with a few questions Iâve gotten from readers like you.
A: In some contracts, annuity payments increase over time, but most do not. Those contracts that do provide payments that grow with inflation tend to have a starting annuity payment that is 20% to 30% lower than a contract with fixed, level payments. Inflation protection is not cheap.
Of course, the question about purchasing power and inflation is timely with whatâs going on in the U.S. and elsewhere. The Labor Department announced in early February that inflation hit a 40-year high, with consumer prices jumping 7.5% compared with last year. If you relied on annuity payments for all your income, the value lost to inflation would be a major problem. But your retirement income plan shouldnât look like that.
First, you have Social Security and possibly a pension, which grow with inflation. Second, when the income from these sources is not sufficient to cover inflation, you will want income from your savings to increase over time, and you should plan accordingly.  In creating that plan, you should consider annuity payments that start immediately, and a second set of annuity payments that start when you reach a certain age (or ages) in the future. The first can provide a foundation of lifetime income, and the second can be deployed in a laddered purchase of annuity payments to achieve growing income. Â
Hereâs an illustration of a plan that provides increasing income over the years and that shows how annuity payments are deployed:
Courtesy of Jerry Golden
A: The answer is no for most contracts â due to the actuarial approach annuities are founded upon.
The reason for no liquidity is that when you receive annuity payments, a portion of the higher payment is enabled by a survivor credit, which represents the benefit of pooling your longevity risk. Unlike life insurance, where the benefit is paid at your passing, under these annuity contracts the benefit is paid at your surviving. If you could cash in annuity payments during your lifetime, youâd undermine the pooling concept â and the lifetime income advantage.
Our typical female retiree aged 70 who wants to increase the cash flow from her $500,000 in low-yielding savings could purchase annuity payments at an annual rate of around 6.75% today, or $33,750 per year. Thatâs the survivor credit benefit. Â If she wanted to ensure her beneficiary a return of the balance of the annuity premium at her passing, the annuity payout rate would be around 6.00%, or $30,000 per year.
 How do you overcome the liquidity issue? Here are a few short answers:
A: These annuity contracts are similar to the pension your parents had. Just like a pension, they provide a lifetime of guaranteed income. When incorporated into a plan for retirement income, annuity payments address the most common fear of retirees: Will I outlive my savings?
Recognizing the benefits of annuity payments, recent revisions to federal law governing qualified retirement plans, like 401(k)s and 403(b)s, made it easier for participants to convert part of their savings to these annuity contracts.
Set out below are some of the other benefits of annuity payments.
Annuity payments allow you to adjust parts of your retirement income plan without giving up on your goal to live comfortably for the rest of your life. In fact, they can be one of several steps you can take to build a safer income plan.
You should not put all of your savings into purchasing annuity payments. A good portion should remain in your portfolio of stocks and bonds, with a concentration in income- and dividend-producing ETFs. In fact, retirees who are not receiving annuity payments will be very unlikely to invest a higher percentage of their equity portfolios in stocks that might generate more robust returns.
I write frequently about the value of staying the course during volatile economic times, which cause some people to abandon sound plans. In fact, statistics show that individual investors underperform the market by 1% to 3% per year on average because they jump out of the market during alarming plunges. This is even more likely for retirees who have no annuity payments. The protection of annuity payments increases your ability to work the market to your best advantage.
Recognizing that your plan is built on several pillars of guaranteed lifetime income allows you to âstay the courseâ during a turbulent market.
Tax legislation and regulation encourage the use of these annuity contracts by offering favorable tax treatment. I believe this treatment granted by the IRS over the years is to encourage retirees to be more self-reliant in their retirement plans.
As I have explained before, the IRS makes you pay taxes only once on money you earn. Here is how that translates into favorable tax treatment for annuity payments.
As we discussed, one convenient benefit of annuity payments is that these guaranteed payments are deposited monthly into your savings or checking account while you are alive, and, if elected, while your spouse is alive. Your beneficiary can also receive a lump sum if you pass before the premium is paid out in annuity payments. Important secondary benefits of those monthly payments include the convenience of using that money to pay your recurring bills (independent of investment returns).
Also, while annuity payments provide income, the resulting higher income can enable a more generous legacy for your heirs, and peace of mind that comes from knowing you wonât outlive your income.
If you are ready to start building a Retirement Income Plan for your specific circumstances, visit Income Allocation Planning at Go2Income. We will ask a few easy questions so you can design a plan that meets your objectives. Whether I have fully convinced you about the value of annuity payments or not, why not research on your own. Click annuity info to compare your annuity payment and tax benefits with our investorâs results in the article.
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For lovers of classical music, there is nothing like the sound of a great symphony orchestra. Itâs amazing to see a finely tuned group of musicians bring together the many different tools of their craft, including brass, woodwinds, strings and percussion, for the purpose of creating music that moves and inspires. Playing each instrument on its own may be nice, but, when brought together to work in concert with each other, the sounds can be amazing!
You can make YOUR retirement AMAZING by thinking about your plan in the exact same way. Over the years, you may have created your wealth by being a diligent saver and deferring many of lifeâs pleasures. You may have accomplished this by using a wide array of investment and insurance tools, such as company 401(k)s, IRAs, brokerage accounts, real estate, life insurance, annuities, CDs, etc. Over time, you probably watched your net worth grow as the values of these tools individually each increased. However, as you prepare to cross that bridge into the retirement phase of life, you will be left to figure out how each of these âfinancial instrumentsâ should be played together, to create your own âRetirement Symphony.âÂ
Here are three steps I encourage you to take to get your concert started:
This can be one of the most important foundational things you can do as you prepare for this journey. Understand that if you created significant wealth throughout your career, you probably did so with an âAccumulationâ mindset, focusing the majority of your efforts on being a regular saver and strategic investor using a wide array of tools and products.Â
When you cross that bridge into retirement, however, your mindset should change from one of âAccumulationâ to one focused more on the âPreservation and Distributionâ of that wealth. Investment growth is still a part of the equation, given that retirement could last over 30 years.  However, you should expand your thoughts beyond just investment strategies to thoughts about strategies to address a combination of things, such as:
Itâs important to understand the capabilities of ALL your financial instruments and how you can maximize the positive things they were designed to do. For example, ask yourself what you want from each of your investment accounts going forward. Is your goal to just get a specific rate of return each year because it looks good in traditional retirement planning simulations, OR is the growth you seek for a specific purpose? Those purposes could be for such things as immersing yourself in all your recreational âbucket listâ adventures youâve been dreaming of or just growing a portion of your wealth enough to reach your legacy goals.
What about some of the insurance tools that you own? Do you understand how to maximize the capabilities of all the various annuities and life insurance policies you purchased over the years? Some examples for using these tools may include creating a lifetime stream of monthly income or having money that can be distributed tax free. In addition, these tools could also be an unknown way to pay for the cost of long-term care or provide the opportunity to leave a significant legacy to loved ones.
Whatever your desires are, understand how to maximize your financial instruments to create those sweet sounds.
With any award-winning symphony orchestra, the right conductor will certainly be the centerpiece to bring all these sounds together. Without them, perfection cannot be achieved. The same can apply to having the right person to be the âconductorâ of your retirement symphony.Â
If you have never worked with a financial adviser, the first thing you will need to determine is âwhenâ and âifâ you will relinquish the responsibility of your retirement plan design and oversight to someone else. For those who have grown their wealth on their own, this can be a difficult decision. However, ask yourself if you have the desire AND capacity to take on this responsibility as you get older. You may have enjoyed investing money and watching the market over the years, but are you ready to oversee the âPreservation and Distributionâ phase of life?Â
Once you have decided to hire a financial adviser, finding the right one is next. Because the financial services industry is filled with thousands of advisers, here are a few things to consider:
These are just a few of the many things to consider when determining who will be your conductor ⦠too many to list here!
Use these steps to begin creating your own sweet music and âRetirement Symphony.â
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This was originally published on The Penny Hoarder, which helps millions of readers worldwide earn and save money by sharing unique job opportunities, personal stories, freebies and more. The Inc. 5000 ranked The Penny Hoarder as the fastest-growing private media company in the U.S. in 2017.
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This was originally published on The Penny Hoarder, which helps millions of readers worldwide earn and save money by sharing unique job opportunities, personal stories, freebies and more. The Inc. 5000 ranked The Penny Hoarder as the fastest-growing private media company in the U.S. in 2017.
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