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Having some guaranteed retirement income is particularly attractive in today's world of financial uncertainty. If you know you have a check coming every month for the rest of your life, you can worry less about stock market volatility or outliving your savings. You may also have some regular income from Social Security but it may fall short of covering your bills. If you aren't lucky enough to have a pension, you may be considering an annuity to boost your guaranteed income. But there are several types of annuities with a wide range of fees, nuances and purposes. Some are more suitable for retirement income than others.
Here are five things you need to know before you buy one.
1. They're simple — and complicated.
The basic annuity is easy to understand: With a single-premium immediate annuity, you hand over a lump sum to an insurance company and you'll receive a set amount of guaranteed income for life, no matter how long you live. The payouts are based primarily on your age, your gender and the interest rates when you buy the annuity. For example, a 65-year-old man who invests $100,000 in an immediate annuity could get about $494 per month for life ($5,928 per year). A 65-year-old woman could get about $469 per month ($5,628 per year). Payouts are lower for women because they are likely to live longer than men do. (Note: These amounts are as of May 2020. They are examples only and rates are likely to change by the time you read this.)
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Income annuities “can be useful for prospective retirees who lack meaningful streams of retirement income, like Social Security and pension, or for those whose tolerance for market risk is low enough to make them fearful of what has historically been the optimal inflation hedge — stocks,” says Tim Maurer, a certified financial planner and director of adviser development for Buckingham Wealth Partners.
Not all annuities are simple. They come in many varieties — variable, fixed, fixed-index, immediate and deferred. Income annuities provide guaranteed lifetime income, either now or in the future, while other types of annuities help defer taxes or provide protection from stock market losses. For most people other than the sophisticated, knowledgeable investor, these other types of annuities may not be suitable for retirement income. The rules, the fees and the role they can play in your financial plan can be very different.
2. They require a commitment.
With an income annuity, you can't access your lump sum again after you hand it over to the insurance company. You'll get the largest monthly payouts with a life-only annuity, which continues to pay during your lifetime, no matter how long you live. But there are two important factors to consider before you take this option. First, the payouts stop when you die — whether it's in two years or 30 years. If that 65-year-old man dies after year 2, he would have received only $11,856 in payouts. But if he lives to age 95, he'd receive $177,840 in payouts. And second, it covers only you. If your spouse survives you, he or she would get nothing.
The 65-year old man could get a version of the annuity that guarantees payouts will continue for at least 10 years, even if he dies before then, in return for lower payouts. Or he could get a joint annuity that continues to pay out for as long as either he or his wife lives, but the monthly payouts would be much lower — a 65-year-old couple who invests $100,000 in a joint-life annuity would receive $417 per month for their lives.
Because you can only access that money as a lifetime income stream and don't have the flexibility to take extra withdrawals, be careful before tying up too much of your savings in an income annuity. It's important to keep other money accessible for emergencies and other expenses.
Also, the annuity's fixed payout will lose purchasing power through time. Some companies offer annuities that adjust the payouts for inflation, but those payouts start out much lower. Instead, you can invest the rest of your money for the long-term to help keep up with inflation.
One strategy when deciding how much to invest in an immediate annuity is to add up your regular expenses in retirement, then subtract any guaranteed sources of income you already have (such as Social Security and any pension) and consider buying an immediate annuity to fill in all or part of the gap.
Because of today's low interest rates, payouts for income annuities purchased now are lower than they had been in the past. “While you may avoid market risk with fixed annuities, you're accepting interest-rate risk,” Maurer says.
For this reason, some people consider laddering annuities — investing some money in an annuity now, then later buying more that will pay out higher amounts of income. This strategy depends on two factors: first, that payouts will be higher when you're older. For example, a 65-year-old man who invests $50,000 in an immediate annuity could receive about $247 per month for life. A 70-year-old man who invests $50,000 could receive $286 per month, in part because his life expectancy is shorter. And second, that you might get even more if interest rates rise by then. However, laddering can be complex for many people, so you may wish to speak to an adviser before acting.
Another type of income annuity — a deferred-income annuity — lets you invest a lump sum now but payouts won't start until sometime in the future. If you're still alive by then, you'll get much more each month. For example, if the 65-year-old man invests $100,000 in a deferred-income annuity that pays out starting at age 80, he'll get $1,640 per month. But if he dies before then, he'll get nothing. He could get a version that guarantees he or his heirs will receive at least as much as he invested, in return for lower payouts of $1,270 per month.