Annuities – A Retirement Income Stream Option?
During the course of previous discussions, we have identified three general stages in an individual’s investment lifecycle: building a fiscal foundation (conducted during your 20s and 30s), accumulating wealth (occurring between the early 40s and mid-50s), and pre-retirement, the five-year period prior to your desired retirement age.
During the pre-retirement stage, debt is eliminated and a plan – considering the withdrawal rate (e.g. the 4% rule) and the order of withdrawal from the various retirement accounts – to draw down the retirement nest-egg is developed.
With a sufficient nest-egg in place, debt eliminated, and an understanding that the nest-egg has to be drawn down in a manner to ensure that it will last 30+ years if necessary, the question then becomes, “How can I turn my retirement savings into a reliable retirement income and what type of investments should be held during the retirement period?”
Last week we talked about one potential option. Income funds. These types of funds are geared toward individuals already in or entering retirement. As the name suggests, an income fund is a type of mutual fund that emphasizes current income, either on a monthly or quarterly basis. These funds attempt to meet the objective of providing steady income throughout retirement by holding some combination of government, municipal, and corporate debt obligations, preferred stock, money market instruments, and dividend-paying stocks.
This week we take a look at annuities as an option for turning your retirement savings, your nest egg, into a reliable retirement income stream. There are basically three types of annuities: variable, fixed, and equity-index.
These can either be immediate (you make a single lump-sum payment and set the starting date for the payout to begin sometime in the very near future) or deferred (you build your retirement savings over a period of years, deferring when you begin to receive the income).
Pros and Cons of Annuities – How to Evaluate Annuities [New Retirement]
Variable Annuities: A variable annuity allows individuals to invest their money within a range of mutual fund-like investments options offered by an insurance company. These investments are referred to as sub-accounts. As the name suggests, the returns of a variable annuity are not stable. They will vary with the ups and downs of the stock market. There will be downside risks as well as potential upside gains. Generally, over a longer time horizon, a variable annuity invested in a stock sub-account will likely provide a much better opportunity for inflation-protected income than a fixed annuity.
Fixed Annuities: In short, a fixed annuity offers a guaranteed minimum rate of return for a stated period of time. While a fixed annuity will provide a stable retirement income, the fixed return is very likely to be eroded by inflation.
Some fixed annuities do offer the option to have the payments increase each year. However, as you might suspect, there will be a cost associated with that feature. The cost of the inflation protection aside, these types of annuities generally cost less compared to variable annuities.
Equity-index Annuities: A newer flavor of annuity, this type earns interest that is linked to a stock or other equity index. One of the most commonly used indices is the S&P 500. They differ from other types of annuities because of the way it credits interest to your annuity’s value. Most fixed annuities only credit interest calculated at a rate set in the contract. Conversely, equity-indexed annuities credit interest using a formula based on changes in the index to which the annuity is linked. The formula decides how the additional interest, if any, is calculated and credited. How much additional interest you get, and when you get it, depends on the features of your particular annuity. Additionally, equity-indexed annuities, like fixed annuities, also promise to pay a minimum interest rate. That rate will not be less than this minimum guaranteed rate even if the index-linked interest rate is lower. The value of the annuity will also not drop below a guaranteed minimum.
What Annuities Offer a Retirement Plan [Financial Advisor]
There you have an overview of the three types of annuities. While I have touched on some of the pros and cons, instead of repeating what is already out there, I have included the links to a few articles that do a good job of laying them out in greater detail. As with all decisions regarding retirement planning, I strongly recommend you conduct your due diligence, paying close attention to all fees/costs, prior to committing to any of these products.