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All Contents © 2018The Kiplinger Washington Editors
By Kimberly Lankford, Contributing Editor
| October 4, 2018
As you shift your focus from saving for retirement to withdrawing money in retirement, an annuity can be a crucial part of your income strategy. An annuity can provide guaranteed income that lasts for your lifetime—no matter how long you live—and it’s often a good way to supplement income from Social Security and a pension, if you have one.
But the annuity universe includes products that range from straightforward immediate annuities, which guarantee a monthly payout in return for a fixed up-front investment, to variable annuities with guarantees, which can be complicated and expensive. It’s easy to make mistakes. Here are seven annuity missteps to avoid.
Annuities are a great source of lifetime income, but they can also be inflexible. Immediate annuities generally pay out a lot more than interest on CDs and other fixed investments—for example, a 65-year-old man who invests $100,000 in an immediate annuity can currently get about $6,700 per year for life.
But part of those payouts is a return of your principal, and to get the extra income, you have to give up control of the money: After you give the insurer the lump sum for an immediate annuity, you can’t take it back. That’s why advisers generally recommend investing no more than 25% to 30% of your assets in an immediate annuity.
If you buy an immediate annuity, you’ll get the highest annual payout if you buy a single-life version—one that stops payouts when you die, even if your spouse is still alive.
But if your spouse is counting on that income, it may be better to take a lower payout that will continue for his or her lifetime, too. (Some annuities are guaranteed to pay for a certain number of years, even if you and your spouse die during that period.) The annual payouts for a 65-year-old man who invests $100,000 in an immediate annuity would shrink from $6,700 for a life-only annuity to about $5,660 per year if he buys a joint life annuity that continues payouts as long as either he or his 65-year-old wife is alive.
You can compare how much you’ll receive for different types of payouts at www.immediateannuities.com.
Immediate annuities are easy to compare—find out how much you’ll receive each year for the amount you invest based on your age and the type of payout you choose (such as life only or joint life). But there can be a surprisingly large range of payout amounts from company to company. You can compare payouts from many companies at www.immediateannuities.com.
Or you can work with an insurance broker or go to an annuity marketplace to compare payouts from several insurers. Charles Schwab’s immediate-annuity marketplace, for example, includes six annuity companies with financial strength ratings of A or better.
Instead of an immediate annuity, you can get a deferred variable annuity with payout guarantees, which you usually buy about 10 years before you retire. These annuities let you invest in mutual fund-like accounts that can increase in value, and they promise that you will receive at least a certain amount of income each year for your lifetime, even if the investments lose money. The guarantees tend to cost about 0.95% to 1.75% of your investment per year. And you need to understand the rules for receiving the guarantee.
Annuities with guaranteed minimum income benefits require you to annuitize the account in order to receive the promised lifetime income, which means you eventually have to convert the account into an immediate annuity and give up control of the lump sum. Annuities with guaranteed minimum withdrawal benefits pay out income for life based on your initial investment (5% to 6% of your investment, for example) or bump up your guaranteed payouts based on the highest point your investments have reached, even if they lose value after that. They usually pay less than guaranteed minimum income benefits, but you don’t have to annuitize and can cash in the lump sum if you want.
Older versions of variable annuities with payout guarantees that promise a certain amount of money each year for life often let you take 6% of your guaranteed total amount every year. Newer versions often cap these guarantees at 5%.
Your guaranteed value can be much higher than your actual account value, which can make these annuities valuable in a down market. If your annuity’s guarantee is worth more than its account value, be wary of any broker who wants you to switch (salespeople make a commission when you buy a new annuity). If you cash out the annuity or switch to another one, you’ll only get to take the actual account value rather than the guaranteed value. You may also have to pay a surrender charge of 7% or more if you switch out of the annuity within the first seven to 10 years.
Variable annuities with guaranteed minimum withdrawal benefits usually let you take out 5% to 6% of the guaranteed total value each year. If you take more than that, you can jeopardize the guarantee.
The consequence varies by annuity. Some recalculate the guaranteed amount based on the extra money you withdrew, but others will reset the guarantee based on a much lower payout amount or even nullify the guarantee. Before withdrawing more than the permitted amount, find out exactly how the extra withdrawal will affect the guarantee.
No matter what type of annuity you get, you’re counting on the annuity to pay out for the rest of your life, which could be 20 or 30 years or more. Picking a company with a solid financial strength rating is essential. Many advisers recommend choosing annuities from insurers that are rated A or better.
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