Many people have a long list of “wants” for their retirement—whether traveling the world, making happy memories with the grandkids, or finally writing that memoir. However, most of us have only one nonnegotiable “need”—not to run out of money in our lifetimes.
Retirement years can be a time of increased vulnerability, when we need more care and support. None of us want to magnify that vulnerability by becoming financially dependent as we age.
While Social Security and pensions (for some) can help provide a degree of certainty of lifetime income, these sources often don't fully meet basic living expenses, and this is a gap that an annuity may be well-suited to fill.
A lifetime income annuity, also known as traditional annuity, can act as a source of guaranteed income stream for as long as you live. The basic premise is simple. You pay a lump sum of money to an insurance company, and in exchange the insurer pays you a regular (typically monthly) stream of income for the rest of your life, as if you were receiving a pension.1
As with any financial product or investment, a lifetime income annuity comes with tradeoffs, but annuities can have the potential to provide peace of mind and ease of management that few other investments can match. Some of the unique benefits and features they can provide are:
1. Income that never runs out
While the prospect of a shorter-than-expected lifespan might be met with a deeper sadness, a longer-than-expected lifespan also poses risk to your retirement plan. If you’re drawing solely on your investment accounts to meet living expenses, you may have little choice but to try to guesstimate your lifespan and adjust your withdrawals, accordingly.
An annuity can help relieve not just the risk of outliving your money, but the stress of worrying that you might outlive your money. This is because you'll have consistent guaranteed cash flow no matter how long you live. With guaranteed income for life, you can celebrate the possibility of living to 100, rather than fret over who will pay for it if you do.
2. An easy, predictable paycheck
Even if you’re savvy with your finances, it can be difficult to rely on an investment portfolio to meet living expenses. Some retirees may only feel comfortable spending dividend and interest income from their portfolio, but these amounts may be insufficient. To add, this approach still leaves you facing many decisions on choosing investments and making periodic reinvestments.
You may face even more headaches if you have to regularly draw down principal from your portfolio. In that case, you have to decide which positions to reduce and by how much, and stay on top of rebalancing as you’re making these transactions. To add, even if these decisions are manageable in your 60s, you may feel less comfortable making them in your 80s or 90s.
If you cover your basic expenses with an annuity, then many management decisions could become less burdensome. You tell the insurance company what bank account to deposit your payments into and the money will be input monthly.
3. Income no matter what the markets do
Even professionals can’t predict with any certainty what the stock market or interest rates may do over the short term. While keeping a long-term focus can help investors wait out periods of short-term volatility, these periods can be even more nerve-wracking, if for example, your ability to pay future utility or grocery bills is tied up in the markets.
With a traditional income annuity your level of payout is locked in regardless of where investment returns go. Generating at least some of your income from annuities can also help create a diversified portfolio of income sources, so you’re not overly reliant on one single source of retirement income.
4. Added protection against abuse and fraud
No one wants to imagine that one day they might be unable to make their own financial decisions or worse, be vulnerable to exploitation or fraud. Buying an annuity in your younger retirement years affords extra protection against these unsavory scenarios in later years.
With a traditional income annuity, you make an irrevocable contract with an insurance company and that stream of income will be paid directly to you for the rest of your life, which can give you peace of mind about your decision.
5. Confidence to enjoy your money
Without sufficient guaranteed income to meet essential expenses, nearly every spending decision in retirement can become fraught: Can you really afford that vacation? Should you give that grandchild a less generous birthday present, just to be safe? In fact, studies show that some retiree households spend much less than they can afford, particularly during early retirement, possibly due to fears of outliving their money.2
By locking in a certain level of income, an annuity may help you overcome spending guilt to enjoy the money you worked to accumulate. What you spend today won’t jeopardize your income 20 years from now, so you can go ahead and live those years to their fullest potential.
Tradeoffs of a fixed income annuity
No financial product can protect against all forms of risk, and that's why we suggest that should an income annuity be right for you, it be a part of a variety of investments in your retirement income portfolio. It's important to consider the tradeoffs of income annuities, which can include:
- Giving up control and liquidity. With a traditional income annuity, you give up access to cash in exchange for the promise of regular, reliable income. If something changes in your situation, you won’t be able to get that lump sum of cash back.3
- Potential lack of inflation protection. With the most plain-vanilla annuities, the payment you receive is fixed over your lifetime and won’t rise with inflation. One option to help reduce this risk is by adding a "cost-of-living adjustment" to an income annuity, which can increase your payment each year by a set percentage, such as 1% to 3%.4 Another option is to plan for future inflation when determining the amount of an income annuity you need to purchase, by purchasing more income than is initially needed. Excess income can be saved or reinvested to combat inflation in future years.
- Credit risk of the insurance company. Like other insurance products, the strength of an annuity’s guarantee relies on the credit strength of the insurance company. (It is important to check insurers’ financial strength ratings.)
- Lower assets in case of premature death. An annuity can help protect against the risk of outliving your investments. However, it may result in lower assets available for heirs if you pass sooner than expected.5
- Reduced growth potential. By using a lump sum to buy an income annuity, you choose not to expose your assets to potential market returns.
Buying an annuity can be a major financial commitment. While financial decisions are almost never easy, the payoff of buying an income annuity can mean less stress. It can also mean less uncertainty, fewer tough decisions, and more peace of mind to in years to come.