By Walter Updegrave
People crave guaranteed income in retirement, but they cringe at the mention of the word “annuity.” That disconnect can make it tough to ensure a steady flow of dollars in later life.
One answer: Go with an annuity, but keep it simple.
The appeal of lifetime income is clear in a recent study: Six in 10 people ages 55 and older place a high value on having guaranteed income to supplement what they’ll get from Social Security, according to market researcher Greenwald & Associates and CANNEX, a company which provides annuity-related services to financial institutions. Survey respondents said the benefits of extra assured income include protection against outliving your savings, peace of mind and greater assurance you’ll be able to maintain your lifestyle in retirement.
So why then are so many retirees reluctant to invest their savings in annuities, which are issued by insurance companies and can provide regular income payments for as long as you live? The short answer from the survey respondents: They’re put off by annuities’ complexity and cost.
I would put the results of this study into the “I’m not surprised at all” category. For more than 30 years I’ve been writing about annuities and fielding readers’ questions about them. So I can personally attest that when it comes to annuities most people are (pick a word): confused, flummoxed, misinformed, mystified, baffled, bewildered, totally lost…you get the idea. (To sort through the confusion, read 5 Big Misconceptions About Using Annuities.)
And who can blame them? Some annuities seem almost designed to resist the normal human capacity for understanding, whether it’s variable annuities with their perplexing panoply of fees (mortality and expense, investment management, death benefit and living benefit fees, surrender charges, etc.) or fixed index annuities with their arcane formulas for calculating returns (monthly or annual “point to point,” the averaging method, caps and spreads).
Fortunately, there’s an easy way to get the upside that annuities can offer while sidestepping the complexity and onerous fees. Stick to annuities that eschew expensive bells and whistles and focus instead on what annuities do best: provide reliable income that you can’t outlive. In short, opt for annuities that keep it simple (or at least, given that we are talking about annuities, relatively simple).
There are two types of annuities that fit this description: immediate annuitiesand longevity annuities.
With an immediate annuity, you hand over a lump sum to an insurance company in return for monthly payments that will begin immediately (hence the name) and that will continue the rest of your life, no matter how long that may be. Today, for example, a 65-year-0ld man putting $100,000 into an immediate annuity would receive about $560 a month for life. A 65-year-old woman would get about $530 a month, while a 65-year-0ld man-and-woman couple investing $100,000 could count on a monthly payment of about $470 as long as either one is alive.
A longevity annuity works on the same principle except that instead of starting immediately, the payments begin at some point in the future, say, 10 to 20 years down the road. So, for example, a 65-year-old man who invests $50,000 in a longevity annuity that will begin making payments in 20 years would receive just under $2,000 a month for life starting at age 85. A woman and a man-and-woman couple would receive about $1,600 and $1,125, respectively.
A longevity annuity allows you to feel more secure about spending from your nest egg early in retirement: You know that even if your savings run low you’ll have those longevity annuity payments kicking in later on.
With both these types of annuities, you know what you’re giving up, and you know what you’re getting in return. The fact that you are simply buying a fixed monthly payment makes it easy to compare one insurance company’s annuity against another’s (although you do have to allow for the fact that payments from insurers with higher financial strength ratings from companies like Standard & Poor’s and A.M. Best will generally be lower than those with high ratings). You can compare quotes from different firms and check out their ratings by going to an online annuity brokerage like ImmediateAnnuities.com.
Of course, like any investment, immediate and longevity annuities have drawbacks. If you end up dying sooner than you expect, you’ll have shelled out a large sum for a relatively small number of payments, or perhaps no payments at all in the case of a longevity annuity if you die before the payments begin. That possibility galls many potential buyers. It was the No. 3 objection raised by respondents to the recent survey on annuities.
Clearly, buying an immediate or longevity annuity doesn’t make much sense if you’re pretty certain you’ll die early in retirement. (If you’re married or have a partner, however, you’ll also want to take both of your potential lifespans into account.) And an annuity is superfluous if your Social Security and any pension will cover all or most of your essential living expenses, or if your nest egg is so large that your chances of outliving your savings are minuscule. I’m sure Bill Gates, with his estimated net worth of $86 billion, will be able to manage just fine in retirement without an annuity.
Another downside is that once you give up your money in return for lifetime annuity payments, you no longer have access to it. So you wouldn’t want to put all, or probably even most, of your savings into such annuities.
But if you decide you need more guaranteed income or you just feel more secure knowing you’ll have more assured income you can count on even if the financial markets experience a severe setback—don’t be put off by the complexity and high cost of certain annuities. An immediate or longevity annuity can be an efficient and cost-effective way to get you the lifetime income you seek.