Annuity sales have soared to record levels lately as retirees and those nearing retirement are drawn to the guaranteed income stream offered by these insurance company contracts. The recent rise in interest rates is contributing to that appeal—higher interest rates translate into better annuity payouts. Those payouts are higher this year than they’ve been in a decade, although the precise payout that a particular annuity buyer is offered will vary dramatically based on a range of factors including his/her age and the type of annuity.
But some retirees continue to shun annuities due to their complexity and the potential for big hidden fees. Those are very legitimate concerns, but they can be overcome by choosing the right annuities, says our Bottom Line expert Robert Carlson, editor of the Retirement Watch newsletter. Here’s how to identify the annuities that you can trust—and why retirees and near-retirees might want them in their portfolios…
Focus on Single Premium Immediate Annuities (SPIAs). This type of annuity is easy to understand, dependable and most likely to fit retirees’ needs. With a SPIA, you make a single upfront payment to the insurance company, then receive recurring fixed payouts. With the most common form of SPIA, payouts continue for the rest of your life. Benefits: There’s no risk that the premiums will rise in the future because there is only that one-time upfront payment…the payouts will never be lower than expected because the payouts are fixed by the contract…and there are no hidden fees because the only fees are baked into that easy-to-understand upfront payment.
Another similar type of annuity worth considering: The deferred income annuity (DIA). The main difference between an SPIA and a DIA concerns payouts—SPIA payouts begin within 12 months of when the annuity is purchased, if not immediately…and DIA payouts begin in a later year determined by the buyer at the time the annuity is purchased—it has to be at least two years after the purchase. That makes DIAs appropriate for people who have not yet reached retirement age. DIAs can be purchased with either a single lump-sum payment or with a series of payments.
Other forms of annuities, including fixed-index annuities and variable annuities, are more complex than SPIAs and DIAs—the amount you receive from them each year varies based on the performance of investments or an index. Their complexity can lead to lower-than-anticipated payouts, and they sometimes have steep fees. Unlike SPIAs and DIAs, these are appropriate only for buyers who are very financially savvy and/or who have trusted financial advisors. Caution: Unscrupulous financial advisors sometimes recommend complex annuity varieties because they pay big commissions to advisors, not because they’re good choices for investors.
Don’t choose between an annuity or investing in the stock market—do both. Some retirees treat annuities and stocks as an either/or decision…and when these retirees compare the payments offered by annuities to the potentially substantially greater upside offered by the stocks, they usually opt against the annuity.
But that isn’t a fair comparison—stocks offer far greater upside than annuities because investing in stocks means accepting volatility, while SPIAs and DIAs provide the stability of guaranteed income. Better: View these annuities as a form of longevity insurance—the lifetime of fixed payments they provide protects you and your heirs against the risk that you will outlive your savings. Such security is valuable to many retirees…but so is the growth potential offered by the stock market. Best approach: Divide retirement assets between stocks and annuities. Note: Someone who is putting a lot of money into annuities might want to purchase from more than one insurer to protect against the low probability that an insurer might fail. Also, an insurer might accept a limited amount of money, so the individual might be forced to buy from several insurers.
To decide how much to put into an annuity: Base this on your fixed or regular annual living expenses. Add up the recurring bills that you pay each year—groceries, utilities, insurance premiums and housing costs, for example. You also might want to be sure that some amount for leisure and recreation is covered. Subtract the amount you receive annually from Social Security and other sources of income, then put a sufficient amount in an annuity so that its payments will cover the rest. That way, your basic living expenses will be more or less covered by extremely dependable revenue streams for the rest of your life, while most of the remainder of your retirement savings remain invested in securities such as stocks that have significant growth potential.
You can customize annuities—but it’s often better not to. SPIAs and DIAs are very straightforward forms of annuities, but even these can get a bit confusing when you start to wade through the many modifications and variations available. Don’t become bogged down by these details. While you can add a range of riders to many annuities, each of these is likely to increase the amount you must contribute up front to receive recurring payments of the amount you have in mind. Among the options you’re likely to encounter…
Payments that continue after your death. One thing people dislike about annuities—if the annuity buyer dies relatively young, he might not receive enough payouts from his annuity to recoup the amount he paid for it. Insurance companies offer options that reduce this risk. Examples…
With a “10-year certain and life” income period, the annuity buyer’s heirs receive the remaining payouts if that buyer dies before reaching 10 years of payouts.
With a “return of premium” (ROP) rider, heirs receive a pro-rated portion of the amount paid for the annuity if the annuity buyer dies before a specified date.
With a joint life annuity, the annuity makes its recurring payouts for the remainder of the life of the annuity buyer or the life of a beneficiary, whichever is longer.
Unfortunately, selecting any of these payout options will dramatically reduce the amount you receive from the annuity each year during your life. If you’re purchasing the annuity as a form of longevity insurance and/or as a portfolio volatility-reduction tool, these payout options are not in line with your goals, with a few potential exceptions. If you’re married, it could be reasonable to opt for a joint-life annuity that names your spouse as beneficiary…and if your health or family history suggests that you might die relatively young, then perhaps some form of income period protection might have merit.
Inflation protection. SPIA buyers often are offered the option of adding an income growth factor to the annuity’s payouts. If you select this, the money you receive will increase by some predetermined amount each year—typically 1% to 5%. Inflation is on everyone’s minds these days, so that might sound like a good idea—but if you select this option, the amount you receive from the SPIA at its outset is likely to be 20% to 33% less than it would have been without this rider…and it can take years for it to get to where it would have been without it. It’s also worth noting that this isn’t true inflation protection—in fact, no annuities currently sold in the US offer actual inflation protection. Your payments will simply increase by the predetermined growth factor that you have selected each year regardless of the prevailing inflation rate. If keeping your annuity simple and easy to understand is among your priorities, skip the inflation growth factor—your other investments and Social Security’s cost-of-living adjustments can cover the costs associated with future inflation.
Shop around with different annuity issuers—all at once. In the annuity market, a little comparison shopping can translate to a lot more money in your pocket. There can be up to a 20% difference in the payouts offered from one insurance company to the next for otherwise identical SPIAs, even if you shop only among highly rated insurers. Fortunately, you don’t need to call lots of different insurance agents and brokers to shop around for annuities—there are websites where you can enter your information just once and receive quotes from virtually every issuer. The best of these websites is StanTheAnnuityMan.com, operated by annuity agent and former Wall Street investment advisor Stan Haithcock. The site delivers a range of annuity quotes, is licensed in all 50 states and does not sell customers’ information to third parties.
