Most of us worry about running out of money in retirement. Surveys by many financial companies have shown how big that concern is, no matter how much you earn or have saved.
And with good reason. We haven’t saved enough for retirement, especially considering that life expectancies make it not only possible, but probable, that we will live into our 90s.
For those who have pensions, it’s less of a worry. We know that we’ll have a monthly stream of income, some of us for life.
But these days, only 22 percent of full-time private industry workers have a pension, the Bureau of Labor Statistics estimates. In this new, do-it-yourself world of retirement, most of us save in a company-sponsored 401(k), an IRA, or another plan. Even if we have accumulated a big nest egg, we are left to ourselves to figure out how to turn that money into a stream of income to last a lifetime.
An annuity is one of the only ways to do that if you don’t have a pension. Nearly every financial planner recommends that you put at least a portion of your retirement savings into an annuity. But because they are not liquid, you should limit the portion of your portfolio invested in them.
“If you put in $100,000 and get income for the rest of your life, you don’t get that money back,” says Ken Moraif, financial adviser at Money Matters. “You don’t have access to that money. You need an emergency fund to cover over and above what could happen.”
Matthew Sadowsky, director of retirement and annuities at TD Ameritrade, says annuities are misunderstood.
“Part of the reason is the word ‘annuities’ encompasses so many kinds of products — variable annuities, fixed annuities, immediate annuities,” he says. “Each is so different. There is an annuity that looks like a CD. Another looks like a pension, another has tax-deferred growth. That’s part of the confusion.”
First, let’s cover the basics. An annuity is a contract with an insurance company generally purchased for future income in retirement. In return, the owner receives payments at regular intervals. The basic types are:
•V ariable annuity: This is invested in mutual funds or a pool of managed investments. The advantage is that you benefit if the market rises. The disadvantages are that you pay fees and can lose principal in a down market.
•F ixed annuity: This has no fees and will pay you a guaranteed rate of return — for example, 5 percent a year.
•Fixed-index annuity: This gives you exposure to the market but at no risk of loss to your principal. It is basically a fixed annuity with a variable rate of return based on an index, such as the Standard & Poor’s 500-stock index. The disadvantage: The upside is capped.
•I mmediate annuity: The investor gives the insurer a lump sum in return for a set rate of return and regular income payments until death, or for a specified period. There are no fees.
“Annuities lower the risk of investment portfolios,” says Pete Lang, president of Lang Capital in Hilton Head, S.C. “There are no investment expenses and typically no fees, unless you get a variable annuity.
“For most annuities, the primary purpose is tax deferral,” he says. “But they can also provide guaranteed lifetime income. They all don’t, especially variable annuities, which are notorious for some exemptions that will cut off lifetime income.”
Moraif says the annuity is what pension plans use to generate income to pay their participants. It is something you might want to consider if you need an income higher than what your investments can support, he says.
“It’s like a mortgage payment in reverse,” he says. “The principal and interest are paid to you. The payment can be 6 percent or more per year, depending on age and the prevailing interest rate, and it goes on as long as you live. And you can structure it so it continues with your spouse upon your death.”
But let’s face it. Annuities have gotten a bad reputation over the years because of some unscrupulous salespeople who pushed them on people who didn’t understand them and racked up fees and commissions.
Variable annuities, in which you can lose principal, got the bad rap, says Craig Ferrantino, president of Craig James Financial Services in New York.
“There are instances where an annuity is critical for people’s retirement,” he says. “In cases where someone needs a constant stream of payments for the rest of their lives. Another is if they want market participation and yet some protection for their principal.”
“If you need the money to live on, don’t risk it,” Lang says. “Keep it safe. Annuities mirror the benefits of a pension. Don’t risk what you don’t have to lose. Once you set it up, then I see more retirees are willing to risk some of their remaining money because they know they have that guaranteed income.”
The industry has grown more flexible in recent years, Sadowsky says. “It used to be if you buy a single premium annuity, the insurance company is obligated to pay you for the rest of your life, but if you step out of the house and get hit by a bus, they don’t pay out. Now you can get a minimum pay-out or get cash refunded to your beneficiaries. It is not necessarily the case that you are forfeiting whatever you put in.”
When a person is 50 or older, Sadowsky says, it’s time to determine whether an annuity is appropriate. By then, people are thinking about how to live off their nest eggs.
Find an insurance company you want to be with for 10, 20 or 30 years, one that not only will make good on its payments, he says, but will also provide good customer service.
“This is probably something you would like to get a little more guidance [on],” he says. “You don’t want to purchase it online without a lot of research.”