Even if you’ve spent your entire career stashing away money to pay for retirement, you may still be worried the nest egg you’ve worked so hard to build will not last as long as you need it to.
For one thing, American life expectancies are near record highs, according to the CDC, and the average millennial has more than a 60% chance to live to age 90. While living longer is a wonderful thing, it also comes with challenges. Add rising health care costs and market volatility to the mix, and it’s no wonder running out of money is the biggest concern for those planning for retirement, according to the American Institute of Certified Public Accountants.
What we’re hearing from financial professionals is that, increasingly, their clients are looking for a safe harbor to insulate savings from further market declines, while providing options to share in the upside as markets rebound. An annuity is one way some people choose to address these financial challenges as part of a holistic financial plan.
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Annuities can offer insurance against these factors, allowing you to exchange a lump sum of cash (or a series of payments) now for a tax-deferred income stream in the future. (Of note, usually an annuity contract guarantees a payout for life, but there are also annuities that provide an income stream for a fixed period of time, say 10 or 20 years.)
Anytime you’re spending a significant portion of your portfolio on something, it’s important to understand exactly where your money is going. That’s where solid advice and guidance from a financial professional comes in. If you decide an annuity is for you, ask these questions before purchasing to make sure you understand exactly what you’re paying for:
What type of annuity are you purchasing?
There are several different types:
- Fixed annuity: This type of annuity is the most straightforward, offering you a guaranteed, level income stream over time in exchange for your lump-sum payment upfront, regardless of what happens in the stock market. They typically cost less than other types of annuities.
- Fixed-indexed annuity: Fixed-indexed annuities offer a monthly payment to you, tied to a market index. Your payment may go up or down as the index the annuity is linked to rises or falls, but there’s a cap on how much it can be affected.
- Variable annuity: With a variable annuity, your money goes into a professionally managed investment portfolio, and the value could rise or fall. That means that the ultimate amount of your annuity income will vary, depending on the performance of that portfolio. Variable annuities also often include a death benefit, which pays out to your heirs when you pass away.
Annuities can either be immediate — meaning you start receiving your payout right away — or deferred, meaning you buy the annuity now but don’t get payments until some date in the future. Deferred annuities, also known as longevity insurance, typically cost less than immediate annuities.
Are you paying commissions or fees?
If you buy an annuity from an agent, there’s typically a commission built into the price of the annuity. In addition, there are often fees associated with annuity contracts. These fees might include annual administrative fees, investment and management fees (for variable annuities), or redemption or transfer fees. Many annuities also have a surrender fee, which you pay if you decide that you want to get out of the contract early and get some of your money back.
To understand how much you’re paying in commission and fees, read your contract carefully and ask the person selling it to you how they’re being compensated.
Does your annuity have additional features?
Many annuities offer add-ons or riders, allowing you to create a customized product that meets the unique needs of your financial situation. Such additional benefits may drive up the cost of the annuity.
For example, you might purchase a cost-of-living rider for your annuity, which adjusts each year so that inflation doesn’t eat away at its value. Another common rider is a guaranteed minimum death benefit, which promises that a payout to your heirs won’t fall below a certain level.
Are you buying with a partner?
Couples can purchase a specific type of annuity known as a joint and survivor annuity. These typically cost more than an individual annuity, but less than purchasing two individual annuities. With this type, the couple pay a certain amount upfront in exchange for monthly payments. When one partner passes away, the surviving spouse continues to receive a monthly payment (sometimes at a lower rate) for life.
As the shift away from employer-funded defined benefit retirement plans (commonly referred to as pension plans) to employee-funded defined contribution plans (such as 401(k)s and 403(b) plans) continues, it has placed more responsibility on individuals to plan their own retirement finances, making financial professionals more important than ever.
If an annuity is a good fit for your portfolio, a financial professional can talk through the options and help you understand which type may be best for you. Making sure you truly understand the product you’re purchasing can make it easier to enjoy the peace of mind that comes with guaranteed income in retirement.
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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
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