An annuity is, in its most basic form, a cash purchase product. In other words, you turn over the funds in your pension pot to an insurance company in exchange for a guaranteed amount of income for life. You are effectively purchasing future income by purchasing an annuity. You benefit from the acquisition by never having to worry about retirement income for the rest of your life.
Ask yourself three questions before choosing an annuity:
- Do you want income only for yourself or for you and a partner?
- How do you want to receive the income derived from the annuity?
- What is your current health and how long do you expect to live?
These three questions will determine the best way to establish an annuity should you choose to buy one.
With all the information in hand, you will eventually have to make a decision about the kind of annuity that is best for you. Taking it one step further, you may decide that purchasing an annuity is not the right choice after having weighed up your options. This is why the advice of an independent financial advisor is so valuable. Together, you and your advisor will want to work out what your retirement goals are and how best to achieve them.
Is an annuity right for me?
This really depends on many factors. Ask yourself: What are my retirement goals and objectives? At what age do I plan on retiring? What financial assets do I currently own and what are they earmarked for? What other sources of income will I have during retirement? What will my income tax picture look like in retirement?
The annuity does a couple of things. It can provide you with enough to cover your “needs” expenses, and then you can invest the rest in lower-cost investments to complement that for your “wants.” But at least you know that your basic expenses are covered. If, between pension, Social Security, and some type of guaranteed paycheck, my needs are covered, then I can sleep at night, and if I don’t get to take a vacation this year because the market was down, I can live with that. If I can’t pay my property tax or buy food, that’s something that becomes difficult. Sometimes in pursuit of someone’s wants, they sacrifice securing their needs. This is where annuities can fit in.
For somebody who has a very low withdrawal rate and can assume the risk of the market or can hedge this in some other way, [an annuity is] not necessary. If your house got destroyed and you have enough resources to rebuild it without having a big impact, maybe you don’t need homeowners insurance.
So, it’s something that you have to look at: What’s the probability of this happening? What’s the downside if it happens? And do I have options to be able to absorb that? It’s like any other insurance decision.
Even though annuities can be a great source of lifetime income, that’s a good point that you don’t want to invest too much money into an annuity because you usually can’t access more than a certain amount of money every year — whether you have an immediate annuity, which provides a fixed amount of money every year for life, or a deferred annuity with an income guarantee, which usually lets you withdraw a percentage of your guaranteed amount every year. It’s important to keep other money in accounts that you can tap if you end up having an emergency or large expense, such as major medical expenses, that cost more than your annual payout. To calculate how much money to invest in an annuity, it’s usually good to add up your regular expenses in retirement, subtract guaranteed sources of income (such as from Social Security and a pension) and consider buying an annuity that provides enough income to fill in the gap.
Some entertainers who give financial advice via the mass media, like Dave Ramsey, bash on all annuities for all reasons. It’s easy to see why. Annuities can come across as incredibly complicated financial instruments and not easy to explain in a 20-second radio conversation.
It’s also easier for people like Dave to eliminate all annuities for all reasons, especially when they are selling other products to their listeners, than it is to explain the nuances of why some are good and why some are not so good.
If you are approaching retirement, it is prudent to lighten your stock-market exposure. People near retirement simply can’t afford a big market decline. Known as ‘sequence of returns’ risk, a major decline close to retirement date, can have a huge impact on your financial health.
What are the differences between a variable annuity and a fixed annuity?
If you choose a fixed annuity, the premiums you pay will be invested by the insurance company. The company board will declare a current rate of interest each quarter. If the rate declared is less than the guaranteed rate, the guaranteed rate will be paid. A variable annuity works more like a mutual fund. Your premiums will be invested in stock funds, bond funds, real estate funds or other kinds of cloned mutual funds that have no guaranteed rate of return. Instead, your return will vary based on the portfolio’s performance – hence the term “variable.”
Everyone is different and, therefore, the potential benefits of an annuity are going to vary significantly by individual/household. It’s impossible to guarantee income for life from a portfolio; therefore, so as you reflect on how to build your retirement income plan, it is worth at least considering annuities for your “vote.”
Work with an independent professional who can provide you with unbiased advice, and select the best option for your situation. A process this complicated, with so much of your livelihood riding on the decision, should be handled by an experienced professional.
If you have questions call us at 716565 1300 or 813 964 7100, we offer FREE meetings answering your questions by phone.
Also check our website: www.MintcoFinancial.com
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