Are annuities right for you?
While annuities have many attractive features, they’re not for everyone. If there’s no chance you’ll run out of money, annuities are probably the wrong choice. They make little sense if you have an ample employer pension, since you already have the assurance of an income for life. Nor are they attractive if you’re in poor health: the best payoff from an annuity comes from living much longer than average. And if you’re very wealthy, outlasting your money isn’t a concern either. Warren Buffett and Bill Gates don’t need an annuity.
The other reason people avoid annuities is their finality: once you give your cash to the insurance company, you’re locked in for life. Conventional stock and bond investments, by contrast, provide growth potential and the flexibility to tap your nest egg for a lump sum if needed. And if leaving money to your heirs is a top priority, annuities preclude that option because the payouts end after your death (although you can purchase guarantee periods).
But annuities are not an all-or-nothing proposition. It’s best to think of them as one part of a larger retirement income plan: they can work uncommonly well in a portfolio alongside stocks and bonds. The goal is to figure out the right allocation to each of these assets, based on the trade-off between guaranteed income, access to a lump sum, and growth potential.
How much do you need?
If you rely solely on a portfolio of stocks and bonds for retirement income, you have to set a conservative withdrawal rate in case markets perform unusually poorly or you live exceptionally long (or both). A common rule of thumb if you retire at 65 is to plan on withdrawing 4% of your initial portfolio every year, plus inflation adjustments. But you should have a backup plan in case this withdrawal rate turns out to be unsustainable. Building annuities into your retirement strategy is one of the best backup plans, because they assure a relatively high level of withdrawals with no risk of depletion.
One popular strategy is to use annuities together with government pensions to meet all non-discretionary spending needs. “That provides peace of mind. You know the basics are covered no matter what happens. After purchasing annuities, you can afford to take more risks with the rest of your portfolio, which may actually increase the amount you leave your heirs if you live a long time and markets perform well.
To a large extent annuities should replace bonds in your portfolio, although there’s no perfect formula.
If you’re looking for the optimal trade-off between growth and reliable income for life, the best solution may be to transition out of fixed income entirely and end up with whatever combination of stocks and annuities suits you best.
However, “practical issues” will keep most people from going that far. First, you should still keep some short-term investments for emergencies.
You think of an annuity as a kind of “superbond” that produces more income more reliably over a lifetime than do conventional bonds. Insurance companies are able to do this because they pool longevity risks, so those who die younger subsidize the relatively few long-livers. “They’re superbonds in the sense they don’t have the maturity date, so they will continue to pay fixed amounts as long as necessary.”
When to buy an annuity
As with conventional bonds, payout rates for new annuity purchases are greatly affected by interest rates, which are now relatively low by historical standards. However, unlike bonds, annuities pay more if you wait until you’re older before purchasing them. Waiting a few years can pay off, because the benefit of pooling longevity risk is greater as you get older.
Many experts say the “sweet spot” for buying annuities these days is about age 70.
How to buy an annuity
Given the financial industry’s penchant for promoting products, it can be surprisingly hard to find someone to sell you annuities. For one thing, although annuities are really an investment product, they can only be sold by someone with an insurance license. So unless they are dual licensed, investment advisers may not be able to help you with annuities even if they want to. To work annuities into your portfolio, you should have an investment adviser with the right licenses, who is committed to using annuities in the appropriate circumstances. If your adviser can’t do that, consider switching. “It would certainly raise a red flag if my adviser said, ‘No, I don’t do those.’
It may take time and effort to find an annuity approach with which you can be comfortable, but the rewards can be enormous. “It’s a steady paycheque you cannot outlive,”
“Nobody is telling you to put all your assets in it. Nobody is telling you to do it all at once in an irreversible manner. It’s something you should be transitioning to slowly.”
If you have questions, need to buy an annuity or consult with a financial advisor about annuities call 813-964-7100 or visit online
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