There are a host of insurance tools available to older Americans to protect against loss of assets—long-term care, liability, and property and casualty insurance are just a few. But what about running out of assets? With increasing longevity in the U.S., many retirees and those approaching retirement are concerned about their savings lasting their lifetimes.
Several types of annuities that can be used as an insurance strategy to protect against this risk. With a variable annuity, for example, you can peg your payouts to a range of market returns. Alternatively, a longevity annuity enables you to count on getting specific payouts when you reach 80 or older. The ultimate goal is to turn capital into a fixed-income stream to guarantee cash flow in retirement.
Create a “Defined Benefit” for Yourself
One reason why annuities are getting increased interest is the demise of pensions, which historically provided a defined benefit (steady payout) to retired employees. Annuities replicate that “payout-until-death” model, although their fees can make this an expensive proposition. Depending on the annuity contract, early death or a change of heart might mean the loss of all or some of the upfront payment, even before payouts kick in. Money invested in the annuity is not available for long-term objectives like bequests and philanthropy. And withdrawals for an emergency can face a steep surrender charge.
On the plus side, those who prefer straightforward, no-surprises retirement planning can rely on annuities for some degree of income consistency and certainty. And unlike 401(k)s and IRAs, there are no limits to how much income you can defer with an annuity.
These are some basic types of annuities – and their key pros and cons:
You make an upfront lump sum payment to the insurance company and immediately begin receiving payments on a regular basis.
- Flexibility: You and/or a person you designate can be the recipient; you can also structure the payments to last for a set time period.
- You get a guaranteed income stream for life.
- Typically, payouts are interest-rate sensitive; when interest rates are low, these may not be adequate to meet your cash flow needs.
- If you die early – or within a specified time after purchase – your lump-sum investment is lost to your heirs.
Deferred Income Annuities
These annuities begin paying out at some future date that's fixed at the outset and are popular with those who anticipate surviving well into old age. Longevity Annuities are deferred annuities whose start date typically begins at age 80 or older.
- You're guaranteed a consistent income later in life.
- The ultimate payouts can be high, as you’ve deferred income for a specific time period.
- You may not survive to see any payout at all.
Two popular types of deferred annuities are Fixed and Variable:
Instead of setting a start date for payouts at the beginning, you have the flexibility to decide when. The payout amount is still dependent on prevailing interest rates.
- Your investment in the annuity contract will likely get a higher interest rate than with a CD or a savings account.
- The interest you earn is tax-deferred.
- It may be difficult to make unscheduled withdrawals without paying penalties. And there’d be tax impacts to any withdrawals as well.
Your returns are based on the market or markets of your choosing, most often through mutual funds. You can build a contract just as you would allocate assets in an investment portfolio. For example, you could choose to have the broader U.S. equities market for your investment exposure. Or a highly specific market niche, like small-cap U.S. stocks. Or a combination of stocks and bonds.
The word variable is apt here, as it describes how the accrued value of your annuity will go up and down with the moves of your chosen market(s).
- Historically, U.S. stocks have outperformed bonds; over a long time period, you’re likely to see higher payouts from an annuity that has equity exposure.
- You can structure your exposure to achieve broad diversification, just as you might with mutual funds in an investment portfolio.
- Your gains are tax-deferred until you make withdrawals.
- Many variable annuities set minimum payouts, so there are some protections built in.
- Fees and other expenses (like early withdrawal charges) tend to be high.
Have Questions About Annuities? Contact a Fifth Third Advisor
If you’re concerned about running out of money in retirement, and you've already maxed out contributions to other tax-advantaged accounts like IRAs and 401(k)s, an annuity may be right for you. Like any insurance product, there are costs associated with the protections you receive, but there are also benefits—including peace of mind. It’s important to consult with an investment professional to determine what approaches might best fit your retirement needs and goals.