Annuities for Lifetime Income
While today’s annuity designs can accomplish many different retirement planning goals, annuities were originally designed with one goal in mind—generating an income for life. Today, annuities remain uniquely positioned to deliver on this goal.
There are many ways to generate steady income. Bonds pay interest, stocks pay dividends, and retirement plans can be a source for spendable withdrawals. But bonds eventually mature, stock dividends can get cut, and retirement plans get depleted. There are three ways to generate an income you cannot outlive—social security, pensions, and annuities. Unfortunately, few can live on social security and pensions for retirees have become less common. As of January 2020, the average social security benefit was $1,555 per month.i And, as of 2019, only 16% of private-industry workers had access to a defined benefit plan such as a pension.ii
Why guaranteed income for life is so important
Every retirement income plan has three assumptions:
1. Age: How long will you live? Estimating length of life is subject to significant error. Sure, it is easy to go online and look up your life expectancy. Based on your current age, your sex, and the answer to a few health-related questions, many online tools will give you an estimate of how many years you have left to live. Any life expectancy estimate is just an average though, and actual results can vary widely.
2. Expenses: What will your expenses be in retirement? How will they change? As people get older, they spend less on things like travel and entertainment. However, they spend more on health care—sometimes significantly more. In life, the unexpected happens. Often times, the unexpected can be very expensive.
3. Growth potential: How much will your retirement assets grow each year? Will stocks go up or down? What about interest rates? Sadly, a huge factor in the success—or lack thereof—of any retirement income plan is timing. Anyone who retired in 2009, just as stocks were beginning their 12-year climb,iii has likely benefited from equity performance. Whereas anyone who retired in 2007, just before stocks fell by roughly 50%,iv may have had to cut back on expenses for several years to get back on track.
The more guaranteed income you have for life, the less you are impacted by inaccuracy in these three assumptions. Whether you live longer than expected or there is an unexpected drop in stock prices, an annuity that offers lifetime income allows for comfort in knowing you will have a stream of periodic income, regardless of your age, expenses, or current portfolio.
Generating income with annuitization
The most traditional way to receive lifetime income from an annuity is through a process called “annuitization.” When you annuitize your annuity contract, you turn some or all of the value of the contract over to the insurance company in exchange for a promise from them to pay you a monthly, quarterly, or annual check for the time period you select. Typically, these payments will last as long as you live, or as long as either you or your spouse lives.
As an example, a couple, both age 65, may be able to secure income of up to $10,000 per year in exchange for their joint annuity with an account value of $200,000. This annual payment would continue as long as one of them is living. In addition, in order to make sure they receive the full account value of their annuity even if they both experience an unexpected or early death, the couple could elect to add an option that will pay their beneficiaries either continued income payments or a lump sum equal to the difference between the $200,000 they annuitized and the total payments received prior to their death. Including this additional option would reduce the annual income payments, but is an option that can provide peace of mind that the insurance company will, at a minimum, pay back the entire amount that was annuitized.
Generating income with an income benefit
In fact, a small percentage of the annuities that are purchased in the United States are ever annuitized. As attractive as getting periodic income for life may be, most people have a hard time turning over a significant percentage of their retirement savings to an insurance company. If the goal is to generate an additional $50,000 in annual retirement income, it could take an annuity contract with an account value as much as $1 million to accomplish this, depending on your age and interest rates. It can be hard to see an amount of that size disappear from your balance in exchange for a future stream of income.
Understanding the difficulty of such a choice, insurance companies now make it possible to add an income benefit to most annuities. For an extra fee, of typically 0.75%–1.5% per year, the insurance company guarantees an income payment for as long as you live, in the form of a withdrawal amount from your account value. When you add an income benefit, you don’t have to turn over the full amount of your account value to the insurance company in order to get the income guarantee in the future. Instead, the money in the annuity continues to be yours, and the income you take out each year is withdrawn from that account value. Should the withdrawals cause you to liquidate the account value before you die, the insurance company will continue to send you the agreed upon income amount out of its own reserves. One way to think of it is as income insurance – the fee you pay each year for this benefit is essentially the premium you pay to ensure you will receive income payments for as long as you live.
Who should consider an annuity for retirement income?
Anyone who wants peace of mind in knowing that a specific amount of money will be deposited into their bank account each month, no matter how long they live or what happens in the financial markets, should explore annuities. There’s something very reassuring to know that when the headlines read “stocks plunge again,” you know you have a source of guaranteed income.
Retirement income is not cheap: It takes a lot of money to generate a meaningful lifetime income check, especially in an environment of low interest rates. If you think of your retirement account as your safety net and/or a source of funds to pass directly to heirs, it will likely be difficult for you to annuitize and turn a significant amount over to an insurance company. However, if you think of your retirement account as a means to generate retirement income, then you can consider the annuity purchase as a repositioning of assets to achieve that goal.
Request quotes from several highly rated insurance companies: Just as you shop around for the best auto or homeowner’s policy, you should also shop around for the best annuity income amount. An insurance company’s appetite to provide for guaranteed income changes over time. A company with competitive rates today might not be a few months down the road. Also, always keep in mind that all references to guarantees arising under the annuity contract, including optional benefits, are subject to the claims-paying ability of the carrier.
Get help: Choosing to use an annuity to get income for life is a decision you will live with the rest of your life. Every annuity comes with numerous income options and features. Therefore, it’s important to consult a financial professional who understands and can explain the various trade-offs of each option to find a good fit for your retirement income plan. And be sure to review the annuity’s offering document, disclosure document, and buyer’s guide for important contract details, including fees and charges.
Interested in learning more about the main types of annuities in the marketplace and how they can also be used as long-term, tax-deferred accumulation strategies? Our latest articles on fixed annuities, fixed indexed annuities, structured annuities, and variable annuities will take you across the risk-return spectrum and get you started.
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©2022 SIMON Markets LLC. All Rights Reserved. | 2022.03
This is not intended to be an offer or solicitation to purchase or sell any security or to employ a specific investment strategy. This material is intended as general background information, for educational purposes only, and should not be used as a primary basis to make a decision to purchase an annuity contract. This material is being provided for informational purposes only and does not take into account any specific investment objectives or financial situation of any investor. The information is not intended as investment advice and is not a recommendation about managing or investing retirement savings. Actual annuity contracts may differ materially from the general overview provided.
Prior to making any decision with respect to an annuity contract, purchasers must review, as applicable, the offering document, the disclosure document, and the buyer’s guide which contain detailed and additional information about the annuity. Any annuity contract is subject in its entirety is to the terms and conditions imposed by the carrier under the contract. Withdrawals or surrenders may be subject to surrender charges, and/or market value adjustments, which can reduce your contract value or the actual withdrawal amount you receive. Withdrawals and distributions of taxable amounts are subject to ordinary income tax and, if made prior to age 59½, may be subject to an additional 10% federal income tax penalty. Annuities are not FDIC-insured. All references to guarantees arising under an annuity contract are subject to the financial strength and claims-paying ability of the carrier. This does not constitute legal, accounting or tax advice, and the recipient should consult with his or her legal, accounting or tax adviser regarding the instruments described in this material.
i Fact Sheet Social Security, Social Security Administration, 2021
ii Employee Benefits Survey, U.S. Bureau of Labor Statistics, 2020
iii See S&P 500 index performance from January 2009 to December 2021, available at CNBC
iv “Stock Prices in Financial Crisis," Federal Reserve Bank of Atlanta, 2009