These 6 Misconceptions About Annuities Could Have You Missing Out on Guaranteed Lifetime Income
Having a source of guaranteed lifetime income can give you peace of mind in retirement, but many people still shy away from buying into annuities — financial products that are designed to do just that. While annuities may not be the best choice for everyone, some people who would benefit from including annuities in their retirement plan are missing out on this opportunity for guaranteed lifetime income because they don’t fully understand what annuities are and how they work.
If you fall into this latter category, you may be holding onto one of these common misconceptions about annuities.
I Don’t Need an Annuity Because I Already Have Retirement Savings
Some people believe that having an employer-sponsored retirement savings plan or IRA is enough to carry them through retirement, so they don’t feel the need to add any annuities to their retirement portfolio. However, this doesn’t need to be a one or the other situation — it’s a good idea to have both.
“While you’re building up your savings, adding a fixed annuity can reduce the market volatility in your portfolio because they don’t move up and down like bond funds or stock funds, so it adds some diversification along the way,” said Dan Keady, CFP, chief financial planning strategist at TIAA. “If they start putting a little money away in annuities, they could start building their future lifetime income, and we think that’s important.”
However, if you have access to a pension plan, you likely don’t need to buy an annuity.
“If they have a very big pension plan along with Social Security, they could be in a spot where they really don’t need an annuity because they already have that guaranteed income,” Keady said.
I Can’t Afford To Buy an Annuity
Annuities have a reputation of being unaffordable to the average investor, but you may actually have access to an annuity in your 401(k) or 403(b) plan.
“Then, typically the way they work is like any of the other investments you have,” Keady said. “You pick what percent of your contributions you want to go into the annuity and how much you want to go into this mutual fund and so on, so it’s extraordinarily affordable, because there’s really no difference from the contributions that you’re already making to your retirement account. If you’re putting away $100 from every paycheck, you could choose to put $10 into that annuity within the plan.”
Even if you don’t have access to an annuity as part of your workplace retirement plan, you can find some affordable options on the retail market — though it’s true that there are also some very expensive options.
“The retail market is all over the place,” Keady said. “When you go to purchase an annuity, there might be some companies where it costs $5,000, some $10,000, some $25,000 and some $100,000.”
Annuities Don’t Actually ‘Pay Off’ in Retirement
Keady says that having an annuity can “pay off” in ways that go beyond that financial.
“The first thing I’ve seen in real life is confidence,” he said. “People who have a pension or annuity that’s paying them income that literally can’t run out, they become much more confident. There are benefits — before we get to the math — because of confidence.”
Then there’s the financial side of things.
“A lot of people don’t understand that out of a fixed annuity, you can get a higher income than from bonds, the reason being the concept of risk pooling,” Keady said. “When I retire and take an annuity payment some time in the future, it won’t just be me — it’s a whole pool of individuals. Some of those will live longer and some of those will live shorter, and that allows the insurance company to pay based on life expectancy. If you don’t use pooling, you really need to hold back.”
“You’ll often hear about the 4% rule, where you need to start lowering withdrawal rates,” he continued. “The more income from the annuity means I’m taking out less money from the remainder of my portfolio, which ultimately gives it the chance to grow.”
Plus, having a guaranteed lifetime income gives you the freedom to spend. When you know you will be continuing to receive a pension or annuity payment, you can feel confident about spending this money because you know it won’t run out.
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Annuities Are Worthless If I Die Early
Many people shy away from buying an annuity because they worry that they will die before the annuity reaches the distribution phase or shortly into this phase.
“Let’s say I have a pure annuity and I leave my spouse out of it. I create that annuity income and get hit by a bus the same day. That’s the fear you get from people — what happens if you pass away early?” Keady said. “The reality is that the individual or joint couple that’s taking the annuity can never lose because they’re getting their checks — the only people that could typically lose is the kids or the beneficiaries. They could get back something less. But in the real world, very few people are going to choose a pure life annuity where if they pass away early, there’s going to be nothing left.”
Keady said that most people choose an annuity that is structured as a joint-life option, which provides payouts for the longer-living of two spouses. In addition, many people choose a refund feature, so if they were to pass away early, the remainder of those payments go on to their beneficiaries.
I Don’t Need To Buy an Annuity Because I’m Still Young
There’s a common belief that annuities are best suited for people in their 50s and 60s — but this isn’t the case, Keady said.
“The reality is, like most things, you’re better off getting started early so that you could start accumulating for it,” Keady said.
I Don’t Need an Annuity Because I Can Create Lifetime Income on My Own
“A lot of people say, ‘I know I need income for life, but I can do it on my own. I can create my own annuity,'” Keady said. “And the reality is, you really can’t create your own annuity because you don’t know how long you’re going to live — that’s problem number one. And problem number two, the whole concept of [annuities is that] a whole bunch of people go in and are getting paid over time. You really can’t create your own annuity because the only product that guarantees lifetime income is an annuity.”
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