Annuities and Retirement
Annuities have a role to play in most retirement plans, that role is to protect families from outliving the assets they have spent a lifetime accumulating. Though the term ‘annuity’ may have a negative connotation, in fact annuities can provide guarantees and peace of mind to retirees. Annuities and retirement planning can build a financial roadmap that helps a family secure the income needed to retire and dictate their own lifestyle.
Consider the following philosophy: save as much money for retirement as possible and then live on the interest payments. This is a flawed plan for the simple fact that the lifestyle during retirement will be at the mercy of the amount a family can save, market performance, and interest rates. The planning process should be centered on the lifestyle a family wants to have, building a portfolio utilizing the available tools to make it happen.
But it Worked for My Parents or Grandparents…
Past generations have lived during a different environment, having pensions and social security as the primary retirement income sources and then falling back onto personal investments. Middle class, middle aged families in 2010 have a very different picture. The 401(k) and IRA have replaced pensions for most; while social security will likely exist there is uncertainty about future benefit amounts and qualifying ages.
Current working generations need to plan differently. Personal savings for retirement may be the primary source of income. In any case, retirement savings in all forms is intended to provide income for retirement. The idea of retirement has also changed as medical advancements have bettered the quality of life. Outliving assets is frightening and realistic, annuities can help calm the fears and create more peace of mind.
Annuities Insure Income
Annuities are designed as a protection against the risk of outliving money, which is the reason these accounts are offered by insurance companies. The annuity is not just a ‘tax deferred’ alternative to a certificate of deposit (CD). The CD is a loan to the bank, earning interest and returning the principal at the end of the term. The annuity is essentially the transfer of risk to an insurance company, letting them guarantee a lifetime of income whether life continues to fifty or one hundred and twenty.
All annuities have two phases, the first of which is the accumulation phase where deposits are made and the value can grow from interest and investment gains. The second phase, initiated by the account owner, is the annuitization phase. Annuitize simply means the activation of an income stream from the insurance company to the family.
The risk for both the family and the insurance company lie within the phase of annuity payments. In exchange for the guaranteed lifetime income, the family carries the risk of passing earlier than expected and not receiving the full account value (there are ways to prevent this!). The insurance company takes on the risk that annuitants will live longer than expected, paying out more money than was deposited and earned. These risks and guarantees are paid for by annuity expenses or fees.
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Options for Annuity Payments
There are a number of options when selecting a payout schedule for an annuity. To begin, period certain options are available which will provide equal payments for a set period of time. An example would be ten year period certain, providing equal payments for ten years that will exhaust the account.
One of the most useful planning tools is a lifetime payment schedule or joint life payout. These options provide regular payments for the duration of one or two lives. Families can utilize this option to build on other guaranteed income sources and create a reliable and consistent income stream.
Innovative Tools for Retirement Income
Within the last decade or so, another viable option for receiving income from an annuity has become available. Some annuity accounts will now allow the owner to get a lifetime guaranteed income stream without annuitizing the contract. This is achieved by limiting the withdrawal amount and regulating the risk of the portfolio, but some such annuities may allow as much as a seven percent income stream.
This innovative solution offered by insurance companies can provide the best of both worlds. For instance, consider the following examples of retired families taking advantage of this type of retirement income stream:
Income in a down market
A couple retires and begins joint lifetime income payments without annuitizing. When the market drops after five years, their account value is diminished. However, the payment option they selected provided downside protection, so the payment amount they receive will never be reduced, regardless of market performance.
Rising Income Stream
A widow has been retired for ten years and the current payment simply doesn’t cover her expenses any longer. The investment portfolio within her annuity has performed well over the years. Since the current value is more, she can increase the amount of her monthly payments to keep up with inflation. Withdrawals are limited to a percentage of the account value, not a dollar amount. With some annuities, payment amounts can increase but will not go down.
Preserving a Death Benefit
A newly retired couple needs income from their annuity, but wants to be sure they leave something for their three children. Unlike annuitization options which may eliminate their principal, choosing this type of payout option will give them the opportunity to leave money to beneficiaries. In some annuity accounts, the death benefit will be the higher of the account value or initial deposit minus any withdrawal amounts.
Important Things to Remember
Annuities are an important part of retirement planning. The insurance for income and against outliving money can be invaluable. Though there are exceptions, annuities should compose only a portion of a total portfolio. Many annuity accounts have surrender fees and penalties for early withdrawals (within the first number of specified years of taking the contract). Remember, in exchange for the fees and expenses a family gets guarantees and insurance for their income later in life.
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