While you’re working, you probably don’t think too much about how nice it is to have that money coming into your account on a regular basis. Layoffs, transitions, and retirement can change this. With layoffs and transitions, it’s hopefully a short-duration event that you’ve built an emergency fund to help with. But what happens when it’s a permanent change for retirement?
The loss of recurring income is something many retirees who don’t have pensions struggle with…even though who have significant savings. But what if there was a way to create this steady stream of income that will pay you for the rest of your life? Can you create your own personal pension? That’s where annuities can come into play. Because June is annuity awareness month, I thought it was as good a time as any to write about annuities.
Note for military retirees or those with pensions: You may have enough guaranteed income, but I encourage you to read on as I also talk about when I plan to use an annuity even though I have a pension that covers much of my spending needs.
Annuities – Good or Bad?
Many people have strong feelings about annuities. I’m sure you’ve seen the commercials or received information in the mail from a company that exclaims I hate annuities and so should you. The thing is an annuity is simply a tool. Annuities are extremely useful for some jobs, but are totally inappropriate for others.
What Is An Annuity?
An annuity is a financial product usually offered by an insurance company that is designed to provide a steady stream of income over a specific period or for the life of the owner(s). You pay the insurance company either a lump sum or payments over time and they agree to pay you regularly either immediately or at some time in the future.
There are several types of annuities, each with its own purpose and payout structure:
- Immediate Annuities – Start paying you within a year of making your lump-sum payment. These are often used by retirees who want to convert savings into a predictable monthly income right away.
- Deferred Annuities – Allow your money to grow tax-deferred until you’re ready to start receiving payments—could be many years later or possibly never.
Within those categories, annuities can also be:
- Fixed – Offer guaranteed payments often level or possibly increase at set rate over time
- Variable – Payments fluctuate based on the performance of underlying investments
- Indexed – Tie returns to a market index like the S&P 500, offering a middle ground between growth potential and downside protection.
Annuity Benefits
Annuities have several benefits for retirees:
- Reduce longevity risk – Provide a lifetime stream of income no matter how long you live
- Providing predictability and simplicity – This is important as you age and your ability to manage your finances decreases. It can also reduce the risk of elder abuse or scams as you no longer have the large amount of assets that could be stolen.
- More confident spending – Many retirees end up underspending because they are worried about running out of money. Studies have shown that retirees with pension or annuity income are happier in retirement than those who don’t have guaranteed income.
- Tax Deferral – The growth within an annuity is tax-deferred until you withdraw it. In general, I think this is an oversold benefit unless you’re maxing out all of your other tax-deferral options (401K, TSP, IRAs) and even then a taxable brokerage account could make more sense because of step up in basis at death and long-term capital gains rates that are lower than typical income tax rates.
Should You Consider An Annuity?
It depends…the go-to financial planner answer. I recommend clients have enough secure, guaranteed income they can’t outlive to cover their minimum lifestyle expenses. These are things like food, housing, healthcare, utilities, and transportation. For most military retirees, your pension, VA disability (if applicable), and Social Security will cover these expenses. For retired officers or those who served 25+ year their guaranteed income covers the minimum lifestyle expense and much or all of their discretionary spending. If that’s your case, you probably don’t need an annuity.
When I Plan To Use An Annuity
My wife and I fall into the camp of those whose pension, VA disability, and eventual Social Security will cover nearly all of our projected income needs while I’m alive. So I don’t think I’ll ever buy an annuity. But, I have left instructions that should I pre-decease my wife, that she should definitely consider it. We only took partial coverage for the Survivor Benefit Program (SBP) so much of our guaranteed income will be reduced to my Social Security benefits (since I was the higher earner) and the partial SBP at my death. My wife isn’t interested in investments or managing the finances so setting her up with a guaranteed stream of lifetime income will be much better for her.
Do You Need It Now?
While this article highlights some of the different types and categories of annuities, there are MANY, MANY different options, complexities, and costs that go with the different types. My favorite and the one I’ll recommend my wife put in place is called a Single Premium Immediate Annuity or SPIA. SPIAs are straightforward without many options or bells and whistles that drive up the cost of an annuity. She’ll give the insurance company a lump sum of money and they’ll agree to pay her a set amount of money either monthly, quarterly, or annually.
The reason it makes sense to wait to purchase it is because I don’t know if we’ll actually need it. If my wife dies before I do, I’ll have plenty of income from my pension, VA disability, and Social Security. While we could buy a deferred annuity that could grow over time these products often have significant up-front and ongoing expenses. I believe I’m likely to do better keeping the money in my current investments and only annuitizing what my wife needs if and when she needs it.
Wrap Up
Annuities are a great tool for turning a lump sum of money into a steady stream of income. They can also be very complex. Many military retirees may not even need more guaranteed income. But if you are considering purchasing one, make sure you’re talking with someone who is a fiduciary and not just an annuity salesperson. This will ensure you’re using the best tool for the job you need done and advice that is in your best interest.
Have questions about annuities or need to determine if you have enough income for retirement? Schedule a call with Mike to talk about that or any other financial questions you might have.
