Annuities and Retirement

In spite of annuities not being all that popular as far as options for providing for retirement go, in many cases they can be a very effective means to supplement one’s retirement income and may present some real advantages over other forms of investment.

Annuities are an insurance product and are sold only by those licensed to sell insurance, and this may be one of the reasons why annuities tend to fly under the radar of many people, as we tend to get the bulk of our investment advice from those not licensed for annuities.

If your company or bank does not offer annuities, it only stands to reason that you aren’t going to promote them much. People usually think of insurance agents only when they need insurance, and annuities aren’t exactly like most other insurance products and are much more like mutual funds.

Annuities are underwritten the same way as life insurance products are, which is what makes them different, and therefore one’s life expectancy factors into them. If you purchase a life annuity, it certainly will, but even if the term is a limited one, for a certain number of years, then your life expectancy may factor into the equation should the terms dictate.

Your life expectancy does not pertain to other investments, as the value will persist regardless of whether you pass away or not, but most annuities are based upon making a certain payment to you for as long as you live, so how long you may live matters a lot.

Annuities Can Be Used as a Do It Yourself Pension

This does serve to make annuities more like a pension plan, where the insured purchases a certain income stream over one’s lifetime. Annuities offer the choice between a fixed payment, which is similar to a defined benefit pension, where a variable annuity is tied to investment performance.

Most people choose fixed payment annuities due to the fact that it is seen as preferable to define the benefits of the annuity, and this is the reason why people strongly prefer defined benefit pension plans. These pension plans have gone out of style over the last few years, as employers have moved away from them due to their increased costs, a decision which many employees lament.

Being able to depend on a set payment each month or over whatever period you select is a real benefit though, as this allows for one to ensure that their needs are taken care of regardless of what happens in financial markets.

The ability to realize this stability and peace of mind is by far the biggest reason to buy an annuity, although often times people don’t consider these benefits and end up exposing themselves to more market risk than they would should they have given enough consideration to annuities.

Should one instead choose a variable benefit annuity, one often can select a minimum payout, and in some cases should the minimum payment be sufficient, they can poise themselves to take advantage of significant growth in the market should it occur.

For the most part though, given that the primary goal of annuities is to provide income security, choosing a fixed benefit is usually the best choice. If one still wants to speculate in the markets and has the resources to do so, over and above what it takes to set up an annuity to take care of their basic needs, there still is of course the opportunity to invest in a growth portfolio over and above the annuity.

Growth Investments Are Often Ill Suited For One’s Retirement Years Anyway

What most people do not sufficiently appreciate is that significant investing in the stock market is usually not appropriate for many investors in their retirement years. While the industry does generally push people toward holding a significant portion of their portfolio in the stock market, in mutual funds typically, this does not mean that this is a good idea.

It may be though, if the portion invested in growth will not be needed either for a long time or ever. Unless one has enough resources to invest in a hedge fund, or to have their portfolio privately managed, or choose to manage it themselves, this will mean that mutual funds are the only option that is considered.

Mutual funds are always long the stock market, due to a number of factors including regulation, and are ill prepared to ride out long term bear markets, where stock prices go down instead of up.

If one’s time horizon is long enough to ride this out, being long the market exclusively can be a viable option, but given that bear markets can last 30 years or more, one does not really have that long of a horizon in retirement, or even as retirement is approaching.

Perhaps there is a component of their portfolio that they do not require or intend to use, where they may be growing it with the intention of leaving it to their heirs, but often times retirees do need this, and they cannot or should not want to take on the risks that mutual funds pose in the short to medium term.

Annuities, on the other hand, take this all out of the equation, allowing the annuitant to essentially take advantage of a growth strategy without bearing any of the risk. The insurance company isn’t concerned about market fluctuations, as they are much more able to ride out these storms than we are, so they can offer the benefits of a growth portfolio without the risk.

So, instead of putting your retirement savings in the market and being subject to these drawdown risks, or risks of a negative return over the intended investment period, with an annuity you can receive a better return than other alternatives such as savings vehicles, with even more stability than savings vehicles provide.

What Annuities Really Insure

The biggest risk, or at least the most significant one, when in retirement or considering one’s fate in retirement, is your running out of money at some point. While people usually have some base income from pensions, this often is not enough to provide for what one may consider a minimally comfortable lifestyle.

If this were the case, and sometimes it is, then there would be no real need to be so concerned about one’s retirement income, and we could approach this just like we do during our working years, to look to invest simply to become more wealthy and enjoy a more lavish lifestyle.

In retirement though, the goal is to provide a reliable source of additional income, over and above what we can count on from our pensions, to both enjoy life more and to ensure that we are provided with enough income to meet our day to day expenses, without having to worry about going broke.

Whenever we buy insurance, we purchase protection against a certain risk or risks, and annuities provide us income protection against the risk of going broke. It also protects us against this happening due to market fluctuations, and unless we are quite well off, this is going to be a concern to some extent.

Some people are wealthy enough that an annuity wouldn’t make any sense, given that they have enough money that running out isn’t even realistic. For the rest of us though, who may indeed run out, or with those of us who are worried about this and would benefit from the peace of mind of knowing that we’ll have enough no matter what happens in the markets, annuities can be a viable option and a good choice in many cases.

Deciding To Purchase an Annuity

There is always a premium to be paid with insurance, and this premium, representing the difference between what one could achieve investing the money ourselves and what we end up getting, can differ, so it does pay to shop around for annuities.

While one typically buys annuities through an agent who sells life insurance, there are now options which allow people to buy annuities directly from insurance companies, taking the agents and the additional costs and commissions out of the equation and therefore offering more value to the client.

The terms and conditions of an annuity can also differ, so one needs to pay close attention to them, although with annuities the differences usually aren’t all that substantial. For instance, the fees or the conditions for surrendering the annuity and taking its present value in cash may differ, but ideally one does not really want to be doing this, unless one’s circumstances really dictated it, as this goes against the purpose of annuities.

Some people change annuities from time to time, which involves surrendering the present one, paying a fee for that in many cases, and purchasing a new one. This is not something that should even be considered though unless there is a very good reason to do so, and often there is not.

There are also a number of options that are available with annuities, which differ according to the company offering them, and this is one of the reasons why many people look to buy them through an agent who can advise them. Given the fact that annuities often involve a one-time decision, and the fact that it can cost 7% or more of your investment to back out of them if a mistake is made, it is important to carefully consider your options prior to buying an annuity.

Unlike other forms of insurance, annuities do not require regular premium payments, and are usually purchased in lump sums. As well, the actual premium is not money out of hand, it is opportunity cost, the opportunity cost in a market where one often has no business in in the first place. If you shouldn’t be in the stock market anyway, this opportunity cost becomes rather meaningless, as if the value you are getting is higher than an appropriately conservative alternative, as is generally the case, this represents a benefit, not a cost.

That represents the real beauty of annuities, and while the returns they provide are less than what you could get on your own by investing more aggressively, they aren’t that much less compared to a mutual fund, and the opportunity cost here is really only a theoretical one, because it is often not appropriate for those in their retirement years to take on this much risk.

Insurance companies are more than happy to not only take on these risks, they will also take on the additional risk of your running out of money, leaving their clients in what may amount to be an ideal position.

Annuities therefore, when used properly, can often be a great deal for retirees and can in themselves take care of one’s income needs for the rest of one’s life, allowing us to just sit back and enjoy our retirement years.