Today’s retirees are living longer, but longer life has a down side. Even those who have saved diligently for retirement may run out of money.
An annuity can help, because, like Social Security, it can typically provide income for as long as you live.
Defined Contribution Plans
Of course, as people started living longer, most employers stopped offering a lifelong pension. Instead of a traditional defined benefit pension that paid a set amount for as long as the retiree lived, today’s employees typically have a defined contribution retirement plan, such as a 401(k) plan.
Defined contribution plans give employees many investment options, but the contributions stop when employees retire. Defined contribution plans provide matching contributions and tax-advantages, but employees have to manage their retirement investments and contribute to funding their retirement.
Unless employees retire with enough money to live off of the income their investments generate, their assets will start decreasing. Retirees may be fine when they first retire, but over time inflation will increase their cost of living even as their savings dwindle. And the longer they live, the more likely they will be to experience a shortage of funds.
Avoiding a Shortfall
One way to avoid a shortfall is with an annuity, since it provides life-long income. An annuity is a tax-deferred-accumulation contract in which the buyer contributes a lump sum or series of payments and, in return, can receive regular payments for life.
Investors can choose between fixed annuities, which provide a guaranteed principal and a guaranteed return, and variable annuities, in which the value fluctuates based on the performance of the underlying investment accounts. The guaranteed principal and return from a fixed annuity are based on the claims-paying ability of the issuer.
Payouts from fixed annuities do not change over time and, therefore, do not keep pace with inflation. Using variable annuities, investors can allocate their funds to equity-based or bond-based investments with a wide range of risk and potential return.
While past performance is not necessarily indicative of future performance, variable annuities have the potential to keep pace with or exceed the rate of inflation. However, fees are often high and variable annuities may carry surrender fees.
Like qualified retirement plans, taxes are deferred on any growth within annuity accounts. Earnings withdrawn are subject to taxation and, prior to age 59½, may be subject to a 10% IRS penalty. Unlike many retirement plans, there are generally no limits on the amount of money that can be invested in annuities and many variable annuities even offer death benefits.
Can’t decide between a fixed annuity or a variable annuity? You can also invest in a hybrid annuity, which combines the features of both.
Another compromise choice is an index annuity, which will provide a growth rate based on the performance of an equity index over a certain term.
Other Types of Annuities
Annuities can also be designed with many different payout options. The simplest annuity is a single life annuity. The owner receives income throughout his or her lifetime, then payments end, even if the owner has received just one payment. A joint and survivor annuity continues to provide income to a survivor after the death of the owner, typically at a rate of 50%, 75% or 100% of the original level.
Immediate annuities begin providing payments immediately after a lump-sum payment. Deferred annuities, though, are typically more appropriate for those who are saving for retirement, as payments can begin at retirement when they are needed most.
One downside of annuities is that payments typically stop when the annuity owner dies, even if death takes place after only a single payment. One solution is to invest in a period certain annuity, which will guarantee payments for a given period.
These are just some of the different types of annuities that are available. Before deciding which type of annuity is best for you, you should determine whether an annuity is the best possible use of your funds.
Experts typically recommend annuities to those who have invested the maximum amounts in their retirement plans and are looking for other options for their savings to ensure that they have enough money to enjoy their retirement – no matter how long they live.