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Social Security Won’t Be Enough: 3 Reasons to Consider a Deferred Income Annuity

Insights & Ideas Team •  October 19, 2015 | Enjoying Retirement, Your Finances

Will you have enough money to live on in retirement? The question keeps a lot of us up at night. A quarter of Americans aren’t sure if their savings will last through retirement. And, according to Northwestern Mutual’s 2015 Planning and Progress study, 52 percent of Americans haven’t taken any steps to address the risk of outliving their savings.

It’s important to take steps now to build a plan that maximizes spending power while ensuring your income lasts throughout your retirement. And, new research offers a roadmap to accomplish that goal.

The study was conducted by Texas Tech University Professor Michael Finke, PhD, CFP®, and Dr. Wade Pfau, professor of retirement income with the American College. It set out to answer two questions: If you have a goal of spending a certain amount of income each year in retirement, how much will you really need to save—on average—given that you don’t know how long you’ll live or what will happen in the markets? And second, to what extent can having the guaranteed income of an annuity—which is not subject to the ups and downs of the market and lasts a lifetime—help you achieve the goal?

The researchers looked specifically at a deferred income annuity (DIA), which is a contract you sign with an insurance company in which—in exchange for a single payment you make today—you receive predictable, guaranteed income that begins sometime in the future and continues for as long as you live. 

“We studied thousands of hypothetical retirement scenarios that involved different combinations of interest rates, market returns and length of retirement, both with and without a deferred income annuity,” said Finke. “We considered best-case scenarios, worse-case scenarios and everything in between and found that, on average, when retirement income includes a deferred income annuity, the annuity softens the financial blow of factors that can negatively impact spending power in retirement, like living a long life or retiring during a time of poor market returns.”

The research, commissioned by Northwestern Mutual, concluded there are several ways a DIA can help to protect your spending power in retirement. Here are three of the findings:

1. A deferred income annuity can help minimize the impact of a market downturn. You can’t control ups and downs of the market, but an income annuity can help you reduce the impact of market volatility. “By taking money off the table now to fund an income that begins later in life, you can lock in a portion of guaranteed income that won’t be subject to the ups and downs of the market.” Finke says this can be especially important as you near or begin retirement, a time when your investments won’t necessarily have time to recover from a downturn in the market and when losses can have a devastating and long-lasting financial impact.

2. A DIA strategy can still allow you to take maximum advantage of market upturns. Because you will have locked in a level of financial certainty with an income annuity, you may feel comfortable taking a greater risk with your remaining investment assets so that you can take full advantage of market gains. And in the end, you may end up with little or no loss of legacy. “One of the things that surprised me from our research was how this may play out in terms of leaving a legacy to your kids or to charity,” said Finke. “If you have a $1 million portfolio and you buy a $200,000 deferred annuity, you’d think that the amount of money you’d be able to leave for a legacy would go down by $200,000. But we found that because the annuity supports your level of spending with guaranteed income, you don’t have to draw as much from your other investments, giving them more time to grow. In many of these hypothetical scenarios that included an annuity, the legacy ended up being as large or larger.”

3. A DIA can help you protect yourself from your future self. Will you be able to make sound financial decisions when you’re 85? Earlier research conducted by Finke and others suggests financial literacy falls gradually in old age. By the time we reach 90, over half of us will experience cognitive impairment. Having sources of guaranteed income such as a deferred income annuity offers protection from having to make significant financial decisions in old age, according to Finke. “We will all have challenges in our ability to manage money if we live into our 80s and 90s. The annuity automates the process of having to figure out the right amount of money to withdraw from our retirement funds each month.

Much like a pension did for previous generations, a deferred income annuity is one way to create a steady stream of income that you can’t outlive and that can supplement the guaranteed income provided by Social Security. By adding a deferred income annuity to your financial plan, you’ll also be doing yourself a psychological favor, according to Finke. “You can free yourself from feeling anxious about spending money because you know that guaranteed income is never going to run out.”

Learn additional reasons an income can be an important part of your retirement plan by downloading our white paper “Social Security Won’t Be Enough: 6 Reasons to Consider an Income Annuity.”

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