To wrap up our retirement-specific money series, it’s important we touch a bit on annuities. Some may be scratching their head, knowing they’ve heard the word before, yet not exactly sure what it means. So I’ll start from the beginning:
Annuities are retirement investments that you pay into for any amount of time. Once you reach a certain date, you will then receive regular payments for a set period of time, rather than receiving one lump sum like other retirement options. These regular payouts most often continue for the rest of your life. This is a fairly low-risk investment, allowing for a steady income even after you finish working, and unlike other higher-risk investments such as stocks, mutual funds, etc., annuities are guaranteed. The payout is absolutely secure for as long as you are living--no other product offers that sort of security.
As with other investments, the younger you start, the more benefit to you in the long run. In the case of annuities, if you start young, only smaller increments are needed each month. However, if you are 50 and look to start an annuity, chances are you’ll need to put larger amounts away each month. One way to offset that is to put a large one-time payment into the plan (ie. inheritance, work bonus, cashing out stock, etc).
There are numerous annuity payout options that can be added to a plan and it’s important to educate yourself on all the options prior to deciding on one. For example, health is one thing to consider in deciding whether to sign up for an annuity plan because it may affect your payout. If you have a chronic illness, or smoke regularly, you may qualify for what is called an enhanced annuity which will be a higher payout, sometimes as much as 40-50%. Why? The logic is that most likely you may not live as long as a healthy pensioner. Insurers will give you the added advantage because they calculate that your income should be paid out over a shorter period of time. Kind of a morbid thought, but something insurers take into consideration nonetheless.
If you decide on an annuity (longer payout) over a traditional retirement plans (one lump payment), it is important to educate yourself on its pros and cons. An excellent article written by Forbes contributor and CFP(R) practitioner, Eve Kaplan, offers a list of questions you might want to ask yourself before jumping in feet first. For now, I will mention a few advantages and disadvantages that come with annuities:
Advantages: Annuities are tax-deferrable until you start your withdrawals. Once you start your payments, only the gains you make on the annuity are taxed. Unlike other IRA and 401(k) options, there is no limit to how much you can contribute to your annuity. Also, as mentioned previously, annuities are guaranteed. It’s nice to know in our ever-changing economy, that your annuity offers a guaranteed rate of return.
In the above mentioned article, Kaplan mentioned that she tends to lean her clients toward pension annuities--particularly variations of a 75% joint and survivor pension if they are married. This allows the surviving spouse 75% of the monthly benefit for the remainder of his/her life. That is some nice added security for even the living spouse.
Disadvantages: One downside to annuities is that if you cash out prior to the date settled on in the plan, there are early-withdrawal penalties, sometimes as much as 10%. Another disadvantage is that annuities typically carry higher fees, sometimes 2-3%. Prior to settling on a plan, do your research and know exactly what the fees are. Make sure the rate of return you are expecting will make up for the fees charged over the life of the plan.
Above all, find a trusted company to start your investment with, one who will be honest about fees, payouts and any other hidden clauses.
One final word. Hopefully over the last several weeks, you have learned more about what retirement options are out there. Remember it’s your money, your investment. The idea is to make your money work for you, generating real wealth. Warren Buffet said of investing: “Never depend on single income. Make investment to create a second source.”
Let Me Know: What investment decision have you made that has allowed you to generate a second source of income?