How to Decide If a Retirement Annuity Is Right for You
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A retirement annuity can provide a guaranteed stream of monthly payments that lasts the rest of your life. Many retirement experts suggest buying a retirement annuity from an insurance company if other sources of guaranteed income — including Social Security and any pension payments — won’t cover your basic living expenses in retirement.
The potential advantages:
A lifetime payout option means that you can’t outlive the money, regardless of how long you live or what happens in the stock market.
Your investment is protected from other dangers, such as losing the money to fraud, unscrupulous advisors and bad investment decisions as you get older.
Payments are generally higher than what you could expect from other low-risk investments, such as certificates of deposit, money market accounts or bonds.
You may be able to take more risk, and potentially get better returns, from your remaining investments since your basic living expenses are covered.
State guaranty associations protect annuities against insurer insolvency, typically up to certain limits (usually $100,000 to $300,000 for each annuity owner).
The potential disadvantages:
You need a relatively large sum of money, roughly $100,000 for each $500 monthly payment starting at age 65.
You typically have to commit the money up front and can’t dip into it later if you have an emergency.
After you die, your heirs may or may not get a check — it depends on the options you choose.
If interest rates are low when you purchase, your payout will be less than what you would get if you purchased the annuity when interest rates were higher.
To make sure your payments are truly guaranteed, you’ll need to choose a financially strong insurance company and to understand how your investment is protected in case the insurer goes under.
» Read more: When can you retire?
The best type of annuity for retirees
Annuities come in many forms, but the best type for most retirees is a single premium immediate annuity, also known as an immediate fixed annuity. These annuities offer monthly payments that usually begin shortly after they’re purchased with a lump-sum payment.
With this type of annuity, there’s no investment component; the payments are fixed regardless of what happens in the stock market. That’s in contrast to variable annuities, where the value fluctuates depending on the performance of investments the investor chooses.
The monthly payment largely depends on the age and gender of the people buying the annuity:
A single man, age 65, who invested $100,000 in an immediate annuity could receive $529 a month, according to Charles Schwab’s income annuity estimator.
A woman the same age would receive $501 (the smaller amount reflects the woman’s longer life expectancy).
If they were a couple buying the annuity together, the monthly payment could be $438 if they chose the “joint life” option that pays out until the second person dies.
The life expectancy of two people is longer than any single life expectancy. While the life expectancy is 84 for the male and 86.5 for the female, there’s a 50% chance that one of them will live past age 92, according to the Society of Actuaries.
Monthly payouts can be higher if you start the annuity when you’re older or if a couple chooses a reduced payment after the first person dies, says Christine Russell, senior manager of retirement and annuities at TD Ameritrade. Payments may be somewhat smaller if you choose any of the add-on guarantees commonly offered.
You could, for example, opt for “joint life with 10 year certain.” You and your partner would receive the income during your lives, but if both of you die within the first 10 years, your beneficiaries would receive the remaining income payments until the end of the 10-year period. Another common option is a cash refund, which typically gives your heirs a lump sum equal to your original investment minus any of the payments you received.
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What about inflation?
Many immediate annuities also offer some kind of inflation protection. This option tends to make the initial payment significantly smaller, although the checks will rise over time.
The inflation adjustment can be helpful if you expect to live longer than average, retirement experts say. But you already have some inflation protection with Social Security, which has cost-of-living increases built in, Russell notes. Also, spending typically drops as people age and become less active, although health care costs may increase spending toward the end of life.
Another option for people who want to protect against inflation or benefit from higher interest rates is to “ladder” their annuity purchases. That means taking your lump sum and using a portion of it to buy an annuity every few years. If you have $300,000, for example, you might buy a $100,000 at the start of retirement, another one at 70 and a third at 75.
How to choose an annuity
You should get quotes from at least three insurers before choosing an annuity, since payout amounts and options vary. You also may want to buy annuities from more than one company, depending on your state guaranty association’s insurance limits. If your state protects only $100,000, for instance, you could buy $100,000 annuities from three different companies to stay within those limits.
Even though this insurance exists, it’s no substitute for making sure you buy annuities only from financially strong companies. Insolvencies take time to resolve and your payments could be held up for years.
“You want to be sure that the company is well off enough financially and strong enough financially that they can make the payment long term to you,” Russell says.
Check the insurer’s ratings with one or more rating agencies (A.M. Best, Fitch, Moody’s and Standard & Poor’s) — an “A” rating indicates the company is financially strong enough to be around as long as you need it.