Pros and Cons of Retirement Annuities

February 4, 2020

You may be wondering how you will save enough money to cover the cost of retirement and ensure you won’t run out of money, no matter how long you live. Retirement annuities can be a good solution for many people. Because annuities pay out gradually, you will have a steady cash flow over the course of your retirement. There are some disadvantages to retirement annuities too, so it’s important to consider all aspects before investing in one.

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What are Retirement Annuities and How Do They Work?

Retirement annuities may seem difficult to understand, but they’re actually fairly simple. You purchase a retirement annuity from your insurance company, either all at once or by making payments toward it in the years leading up to your retirement. The insurance company will place the money you’ve paid into mutual funds or other investments, and in return, when you retire you’ll receive dividends in regular payments (or in a single lump sum, though that is considerably less common).

Retirement annuities can be fixed or variable. If you opt for a fixed annuity, you’ll be guaranteed a certain minimum interest rate and you’ll receive a fixed number of payments. On the other hand, a variable annuity provides payments based on how much profit your investments make, so payments may not always be consistent. Most experts recommend fixed annuities as the less risky option because they don’t lose value due to unlucky market fluctuations.

Pros of Retirement Annuities

  • Consistent income in retirement: A retirement annuity can be a good way to ensure a consistent monthly income during your retirement years. Most annuities pay from $500 to $800 per month from the time you retire until your death. The amount varies depending on the cost of the annuity, your age when you start collecting (the longer you wait, the more you’ll receive each month), as well as your gender (men generally receive higher monthly payments because men live longer on average).

  • May prevent some money management issues: During the early years of retirement, it can be tempting to overspend on home renovations, vacations, or other large expenses, quickly depleting your nest egg. Or, you may assume you’ll live to be 80 like your parents, then unexpectedly live to much longer. In either situation, it is easy to find yourself without enough savings to last the remainder of your retirement. An annuity can help counteract that problem: Because you won’t have access to all of the money up front, you won’t be able to spend it prematurely.

    You also won’t be able to accidentally give away or spend more than you intend to due to age-related issues. As you age, you may not retain your strong decision-making skills due to cognitive decline or other factors. Because you only receive monthly payments, you’ll be less likely to lose your retirement savings to a poor decision.

  • Reliable income for your heirs: Some annuities provide optional riders allowing you to leave the balance on your account to your heirs if you pass away before using all of it. These retirement annuity benefits are not legally considered part of your estate. When you die, if you have outstanding debts, your family still receives the payments from your annuity instead of the money being given to your creditors.

  • Tax-deferred savings: Any money you contribute toward your annuity is tax-deferred. That means you can put money into your annuity account before paying taxes on it, and you will not have to pay any taxes on it until you begin receiving payments in retirement.

  • Variable annuities offer a death benefit: While most experts do not recommend variable annuities because they are risky, they do have a strong advantage called the death benefit. The death benefit is a payment made to a specified heir on the event of your death. Typically the benefit is equivalent to the cost of the annuity; if you purchased a $150,000 annuity, your chosen heir would receive a $150,000 lump sum. Of course, you can also get this benefit by purchasing life insurance instead of a variable annuity, often with less associated risk.

Cons of Retirement Annuities

  • They’re expensive: An annuity is typically expensive and has to be purchased in full, unlike most other savings options which allow you to put in whatever you can afford to contribute. Most retirement annuities are $100,000 or more for a single individual. Many insurance companies allow you to make payments toward the annuity, but you cannot receive payments on it until it is completely paid off.

  • May have restrictions and fees: Every annuity policy is different, so it is important to read yours correctly before you decide if it is right for you. Most variable annuities carry risk, mortality, and administrative fees, and may also add on fees for additional benefits (called riders), such as the death benefit mentioned above. Fixed annuities typically have fewer fees, but likely still have some. You may also be charged a fee if you need to take additional withdrawals from your account, often called a surrender fee.

    If you haven’t already maxed out your 401(k) and IRA, the Securities and Exchange Commission recommends doing that before investing in a retirement annuity. That’s because these tend to have fewer fees and restrictions than retirement annuities, while still maintaining the tax benefits.

  • Variable and immediate annuities can be risky: Some people opt for a variable annuity with hopes that the stock market will increase their savings over time. But because the market can be unpredictable, you may end up losing money. Immediate annuities can also be risky. While most people opt for deferred annuities that pay out at a later time, some people purchase an annuity with the plan to immediately begin collecting payments. These actually do not begin to pay out until one year and one month after you have paid the entire cost of the policy in full. Since they are so expensive, you may not be able to pay it off in time to use it fully.

The Bottom Line

The safest bet is to max out your contributions toward your 401(k) and IRA first. Then, if you decide a retirement annuity would also help strengthen your safety net, talk with your trusted insurance provider. The lowest risk option is typically a deferred, fixed retirement annuity, but your particular situation may make another option more reasonable.



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