Should I wait to get guaranteed income?

Many people spend their working life saving what they can for their future retirement. But once you get to retirement, the rules of the game change. Now you'll be spending rather than saving and that can be uncomfortable for some people. You'll also need a new plan to help make sure your essential expenses are covered.

One way to make sure you have money available to pay for essential expenses is by adding guaranteed income to your retirement portfolio.¹ The 3 main benefits of guaranteed income are gaining peace of mind, simplicity, and protection. Knowing that you have some income, no matter what happens in the market or in your life, can be freeing.

There are typically 3 sources of guaranteed income available to support retirement: Social Security, pensions, and fixed income annuities. Investing in an annuity can help cover essential expenses that aren’t already met by Social Security or pensions. To learn more about the benefits of income annuities, read Viewpoints on Fidelity.com: How to feel financially secure in retirement.

Once you’ve decided an income annuity is right for you, the next question is often: When should I get it? When interest rates go up, annuity payouts may go up too.

But waiting can come with a lot of risks as well, including a risk to your investment portfolio if you need to cover expenses by selling assets in a down market.

When should you consider an income annuity?

The value of investing in guaranteed income when you need it to cover retirement expenses (versus waiting in hopes of a higher payout if rates rise) is that you can immediately begin receiving the cash flow an annuity provides.

Delaying an annuity investment might result in a financial benefit—but it might not. Here are the components to the cost of an annuity for a certain dollar amount of payout.

• Age: The older you are, the higher your payout may be.
• Gender: Statistically women live longer than men, so women may have a longer payout period, which generally results in lower payouts than men.
• Interest rates: In general, higher interest rates can mean higher annuity payouts.

Interest rates are the wild card because they are unpredictable and variable. But if you're considering waiting for interest rates to go up before investing in an annuity, first consider the potential costs and benefits. The 4 factors below will help determine whether or not the decision pays off. If the last 3 considerations in the table equal or exceed a year’s worth of expenses, then waiting a year may have paid off.

4 factors to consider

Paying essential expenses for an extra year: You will be paying out of pocket for one more year, which could potentially reduce your account balances, leaving you less to invest in the future.

Your return on investments: By waiting a year, you can keep your principal invested (typically in cash or high-quality bonds). Though you are less likely to lose money in conservative investments, like US Treasuries, there is always a risk when investing—particularly in a short time frame due to market volatility and potential for inflation to impact your portfolio..

The cost of an annuity for a specific monthly payment: The price of guaranteed income may fluctuate with corporate bond prices. It could go up—or it could go down.

How old you are: Getting older pays off. Older individuals will have a shorter expected lifetime, so the income payment rates are more favorable (assuming insurance companies use the same life expectancy table after 1-year waiting period).

Let's look at a single hypothetical example to understand these components in context.

In January 2011 Henry decided that a fixed income annuity could cover his monthly essential expenses of $3,000. But he wasn't sure if he should buy it immediately or wait 1 year.

With current annuity rates lower than they had been historically, he thought they might improve. So he resolved to hold his principal in a low-risk, low-yield investment and wait 1 year to make the annuity investment. How did that work out?

Potential outcome from waiting 1 year

As shown in the following illustration, in this case, his expectation was proven wrong.

• His upfront cost increased by $26,667 because annuity rates actually fell during this period, so he would have to pay more to get the same payout as he could have received a year ago.
• He was out of pocket $36,000 because he had to pay for his monthly living expenses all year.

So waiting cost Henry $49,912.

Sometimes waiting can pay off—but is it worth the risk?

Henry's outcome could have been different. In this example, it is November 2012 when Henry decided that investing in an income annuity could make sense. Again he delays a year to see if his payout will improve.

• Henry paid $36,000 for living expenses during the year but earned $204 on his principal.
• Because annuity rates increased, his payout went up relative to 1 year prior.

This time waiting paid off and Henry ended up saving $21,271.

The big caveat is that historically, the odds have been stacked against the investor who may be waiting for a higher payout.

Let’s look at the period between January 1, 1950, and August 1, 2022,² which includes rising and falling annuity rates. During this time frame, waiting a year resulted in a worse outcome 73% of the time, and the extreme outcomes are much worse. During this period, the average cost of waiting a year was about $16,000.

Annuity rates year to year: Most of the time waiting did not pay off

Does rising inflation change the math?

Similar to trying to time the stock market, trying to time an annuity hasn't been particularly effective throughout history. You'll notice though that the big uptick in 2022 in the chart above shows that it is possible to occasionally benefit from this strategy.

But what does that mean for the future? Inflation has been much higher than average over the past year and some analysts expect interest rates will continue to rise, potentially leading to more favorable payout rates. The question is: Is it worth the risk?

Here's how a $1,000 monthly annuity payout today³ would look if you waited a year.

So if interest rates really do increase 1%, there is a marginal benefit. But if interest rates stay steady or decrease, waiting would have a clear cost.

What if I invest the money instead?

All the above assumed that a person considering an annuity would keep their principal in cash during the 1-year waiting period. After all, that might be a logical strategy to protect your money while considering all the options.

But what if you invested in bonds? If interest rates do, in fact, increase, the increasing rate environment could actually lead to losses in the bond portfolio—offsetting much of the expected increase in the annuity rate. And you will still need to pay your essential expenses throughout the year.

So we see that bonds can be risky, but what about investing in stocks? For an investor with years or decades to stay invested, stocks can be a great investment option.⁴ But directing the cash earmarked for an annuity into the stock market could be even riskier than bonds. Generally, Fidelity does not recommend investing in the stock market with money you may need within 3 years or less. For someone planning to retire soon, market volatility could undermine the success of your retirement income plan, meaning you could run out of money in retirement. Read Viewpoints on Fidelity.com: Thinking of retiring into this market?

The bottom line: If you're convinced that the security of an annuity will work for you, and are assured by the fact that your essential expenses can be covered for the rest of your life, it can make financial sense not to wait, but to purchase the annuity when you need income.