A primal fear many investors have is running out of money in retirement.
Avoiding this disaster isn’t easy because there are many variables to consider, like: How long will you live? How will market volatility impact your savings? What health costs will you incur?
Fortunately, there is a way to ensure a steady income stream, regardless of lifespan: lifetime annuities.
Here’s information you can use to decide if these annuities should be part of your retirement planning.
What is a lifetime annuity?
A lifetime annuity is a contract with an insurance company that provides a guaranteed income for the remainder of your life in exchange for a lump sum payment or series of payments.
Lifetime annuities can be structured to include the life of a loved one or provide for payments for a fixed number of years.
Different types of annuities
There are various types of lifetime annuities, such as:
Immediate fixed annuity
With an immediate fixed annuity, you pay a lump sum to the insurance company and receive periodic payments immediately.
While that may seem like a fit to some, one downside of an immediate fixed annuity is that payments may end when you die, the charges may not be adjusted for inflation, and you sacrificed liquidity for guaranteed lifetime payments.
Immediate variable annuity
An immediate variable annuity provides guaranteed lifetime income, which may vary depending on market conditions.
One downside of these annuities is the payment variability, which is subject to market conditions.
Deferred fixed annuities
With a deferred fixed annuity, you pay a lump sum to the insurance company. You receive guaranteed payments that commence at a date set in the future or when you reach a designated age.
A notable con to deferred fixed annuities is inflation risk—unless they are adjusted for inflation, loss of liquidity, and possible termination of benefits when you die.
Deferred variable annuities
Lastly, deferred variable annuities are subject to market risk but otherwise similar to deferred fixed annuities.
Benefits of annuities
The range of available annuities permits you to customize one to meet your needs. You may decide that having a guaranteed income level is important or choose one that enables you to participate in the gains (and losses) in the stock market.
You can risk losing all or part of your investment in the event of your premature death, provide for payments to continue for the life of a loved one, or structure payments for a designated period. Some annuities are inflation adjusted, which ensures your payments keep pace with the historical inflation rate.
Another benefit is tax deferral for annuities subject to market risk. Gains accumulate tax-free until you take withdrawals.
Downside of annuities
Annuities are complex, high-commission products. The annuity salesperson may be incentivized to recommend an unsuitable annuity without fully explaining the downside.
Before deciding to purchase an annuity, you would be well-advised to consult with a financial advisor or a registered investment advisor with knowledge of annuities.
The high costs and fees of annuities can erode the payments you will receive. Some firms offer low-cost annuities and eliminate the commission of insurance agents. Firms that sell low-cost annuities include Fidelity, Vanguard, Schwab, T. Rowe Price, Ameritas Life, and TIAA-CREF.
Getting your funds out of lifetime annuities can only be possible once you have made the lump sum deposit. You can change the date when payments start, but your options will be limited.
You are trading the certainty of payments over your lifetime for market returns, which may generate higher earnings.
Finally, there are adverse tax consequences to holding an annuity compared to investing in a mutual fund. While increases in the value of your annuity are tax-deferred, you’ll pay taxes and marginal tax rate on your profits when you start taking distributions.
If you invested in a mutual fund and held your investment for more than a year, taxes on profits would be assessed at a capital gains rate, which is lower than ordinary income rates.
Assess the lifetime income annuity option
Whether a lifetime annuity is right depends on many factors, including your health, life expectancy, amount of assets, and risk tolerance.
If you decide to invest in an annuity, choose your insurance company carefully. Among the factors, you should consider the following:
- Do they have a rating of A- or better from AM Best?
- Did they sell over $5 billion in direct premiums the preceding year?
- Do they have a rating of B or higher from the Better Business Bureau?
You can review a list of recommended annuity companies prepared by Annuity.org here.