Should You Annuitize Your Retirement Savings?
So you've done it. You've saved a big pot of money for retirement. And now you need to make sure that money lasts as long as you do. Annuities, in their simplest form, insure you against a long life that outlives your assets. Here is how to decide whether an annuity is right for you.
What's in a name? There are several types of products with the annuity name that serve very different purposes. Fixed or immediate annuities provide guaranteed lifetime income. Deferred or variable annuities are asset accumulation products that sometimes have high expenses.
"An immediate annuity can be a good investment for seniors because there's no surrender charge and you immediately get a stream of income," says John Gannon, vice president for investor education at the NASD. As long as that insurance company is around, you will get a fixed income amount for the rest of your life. "Deferred annuities don't necessarily do that for you," says Gannon. "And most people never use them in annuitization."
Find a reputable company. "Make sure you are dealing with a reputable and financially strong insurance company," says Jack VanDerhei, an Employee Benefit Research Institute fellow. VanDerhei recommends that you check your state insurance commissioner's website and ask for a consumer guidebook. You can also contact one or more of the ratings agencies to see if the company is financially sound.
"Be very wary of anyone who is trying to personally solicit you to purchase an annuity," says Casey Rothschild, assistant professor of economics at Middlebury College. "There are a lot of annuity products out there that are not designed in the best interests of the people who are buying them."
Comparison shop. "Among those reputable companies, basically the most important thing is price," says Rothschild. "There is a huge variation for the exact same product across companies at any moment in time." Rothschild recommends visiting www.immediateannuity.com to get an idea of the average prices for people of your age and gender and the different prices for various types of annuities. You can also call up different life insurance companies that have good ratings for price quotes.
Watch for fees and add-ons. At their core, immediate annuities are a very simple product, but extra features come with additional costs. "Every time you put on a feature, you pay for that feature," says Elisse Walter, senior executive vice president of regulatory policy and programs at the NASD. So you need to look at all the fees and charges for additional features you add to the basic annuity. "There are a lot of different types of fees and expenses," Walter says. "And someone needs to break those down and make sure that they understand them."
Bequeath money outside of your annuity. If you plan to leave money to your children, you might be better off putting that money someplace other than your annuity. Some annuities offer guarantee periods, whereby if you happen to pass away in the first 10 years, for example, your heirs will get the payments you would have gotten in the first 10 years. "Avoid these products," advises Rothschild. "If you indeed have a bequest motive, it's a better deal in general to set the amount of money you want to give your children in one place and take a slightly smaller annuity."
Don't annuitize all your assets. It isn't always easy to get your money out of an annuity for emergencies, at least without penalty. "If they have cash flow needs, are not in the greatest of health, or if they might need to retrieve the money they are investing in the near term, an annuity might not be the right product for them," Walter says. "As with other investments, you have to look at diversification and not put all of your assets into a particular vehicle like an annuity." It may be a good idea to keep some of your wealth outside of an annuity for health or other sudden expenses.
Factor in inflation. Some annuities will protect your retirement savings from the erosive effects of inflation, at the cost of lower payments upfront. "Don't be fooled by the lower initial payout," says Jeffrey Brown, associate professor of finance at the University of Illinois-Urbana-Champaign. "Over a lifetime, these products can be quite advantageous in terms of providing retirement security at advanced ages."
For example, a 65-year-old male who invests $100,000 in a fixed life annuity may receive payments of $687.96 monthly beginning 30 days after the initial investment. The same investment in a fixed life annuity with inflation adjustments will produce an initial payment of $500.30, but payments will rise as the CPI increases. Rothschild estimates you will start to see higher payments than with an annuity without inflation protection approximately 10 to 12 years into retirement but cautions, "If we have another period of inflation like we did in the '70s, you really want to be holding an inflation-protected annuity."
Find the correct amount to annuitize. You want the money you are getting in retirement from all sources to be sufficient to cover your everyday needs. "It would be good to have a steady stream of income that looks like three quarters of what I made when I was working," says William Gentry, associate professor of economics at Williams College. But an annuity is not the only way to have a financially secure retirement if you don't have a company pension or some other type of defined-benefit plan. Rothschild says, "Households can get the same kinds of asset control they can get with a fancy annuity product simply annuitizing less of their wealth and keeping some of it in mutual funds, CDs, or bonds."