In this last installment of a 3-part blog series on annuities, I will cover pros and cons of income annuities. If you missed my primer on annuities or the pros and cons of accumulation annuities, you can find them here and here. Today’s blog will focus on annuities for the purpose of providing lifetime income.
- Income for Life – there are fewer and fewer retirees who have real pensions to provide monthly income for retirement. And Social Security alone is not enough to cover the retirement expenses for most people. So, purchasing an income annuity becomes an option for a retiree who wants to turn some part of their lump sum savings into a stream of lifetime income that will supplement their Social Security. This type of annuity helps to mitigate longevity risk, which is the risk that the retiree outlives their money.
- Risk Reduction – clients with lump sum savings for retirement inherently face the risk of that lump sum declining in value, or not growing fast enough due to lower than expected market returns. Purchasing an income annuity shifts that market risk from the retiree to the insurance company who is providing the annuity.
- Lack of Growth Potential – the flipside of reducing the market risk is that the investor no longer has the same upside growth potential. Most income annuities will lock in future payments so that there is little to no benefit to the investor of market conditions improving during their retirement.
- Liquidity – there are typically limitations on the ability of the investor to tap into the balance of an income annuity. Some annuities have no flexibility at all – once the schedule of payments is set, there may be no changes allowed. So, it is important to plan for the potential for liquidity needs through other sources and savings. In other words, it may be unwise to use all of the available lump sum savings to purchase an income annuity with limited liquidity.
I hope I have been able to answer many of the most common questions about annuities with these last three blogs. However, it is impossible to cover all of the variations of annuities in the marketplace so it may be wise to find a financial advisor that you trust to make sure you find the annuity solution that makes the most sense for you. I would be happy to schedule a free initial consultation to answer any questions you may have.
Fixed annuities are long-term investment vehicles designed for retirement purposes. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply.
Neil Manning, CFP, AIF, CDFA, FSA
I am a reformed actuary turned financial advisor, helping my clients with everything from investments to retirement projections to LTC insurance since 2014. Unlike most normal people, I love numbers and finance – I’m currently reading a book about game theory which my wife and two teenage daughters think is unbelievably boring (they are wrong). For more details about my background, check out my website below.