How Today's Annuities Are Different
For the majority of U.S. workers today, pensions are a thing of the past. A recent survey found that from 1998 to 2013, the number of Fortune 500 companies offering traditional defined benefit plans dropped 86 percent, from 251 to 34. Add to that doubts about the future of Social Security and the picture becomes clear for today’s generations of workers: It’s up to each individual to create his or her own retirement income. If you want to create the same kind of predictable, guaranteed income a pension would have provided, you could consider an annuity.
“Historically, annuities have gotten a bad rap—which was partly deserved,” said Scott Sparks, a wealth management advisor with Northwestern Mutual. “They were high-commission, high-fee products that weren’t necessarily good for clients. But today, that’s completely been flipped on its head.”
What are annuities? Annuities are products sold by insurance companies that are designed to create a guaranteed income in retirement. Annuities come in many shapes and sizes, but there are two main types: deferred and immediate. A deferred annuity lets you put aside money today and then—at some point in the future—choose to convert that money into a lifelong income stream. An immediate income annuity allows you to take existing savings and turn it into guaranteed income payments now or in the immediate future. In either case, once you start receiving payments from an annuity, those payments are guaranteed and will continue until you die, similar to a pension or Social Security.
While annuities have been on the market for some time, they continue to evolve to meet the changing needs of consumers. According to Sparks, today’s annuities offer features and benefits designed to overcome the three most common objections that once may have made them a less-than-desirable option.
Historical objection #1: If you die, the insurance company keeps your money.
Today’s reality: You can choose to have payments continue after your death.
With annuities, you have the option to guarantee that your heirs receive the amount you initially contributed to the annuity or continue to receive payments for a pre-determined number or years. “There are a lot of ways you can build in these guarantees,” said Sparks. “For example, you can design an annuity so that a beneficiary will continue to receive payments for a certain number of years after you die. Or your beneficiary could receive a lump-sum payment when you die if any of your original contribution remains. And those are just a few of the available options.”
Historical objection #2: There’s no opportunity for growth.
Today’s reality: There are a number of ways annuities may grow in value.
In the midst of historically low interest rates, it’s understandable that people may not want to lock in an annuity income stream based on today’s rates. But many annuities offer more than the fixed interest rate options of the past, according to Sparks. “Some income annuities, for example, have the potential to grow through dividends,” he said. “You can also design an annuity so that the payouts adjust for inflation over time. And with a variable annuity, your principal is tied to market performance; you can choose from a wide variety of investment options that have upside potential.”
Historical objection #3: There’s no liquidity: Once I buy an annuity, my money is locked up for good.
Today’s reality: Annuities can offer the option to access your money.
Most deferred annuities offer a percentage or dollar amount that can be taken annually, if needed, without a surrender charge. Any amount above that could be subject to a surrender charge. And like most other retirement savings accounts, if you’re under the age of 59½, the IRS can impose a 10 percent penalty. Otherwise, you cannot make withdrawals from an annuity beyond the payments you are scheduled to receive.
“Still, it’s a trade-off many are willing to make in exchange for the confidence of receiving a stream of guaranteed income they can’t outlive,” said Sparks. “Plus, only a portion of your retirement savings should be held in an annuity anyway. You need a mix of assets so that you also have money available in case of an emergency and dollars invested in other ways that have the potential for greater growth.” Also, by strategically diversifying your accounts, you can reduce your tax burden.
As part of a broader financial plan, an annuity is one way to provide a steady stream of income in much the same way pensions provided income for previous generations. They’ve come a long way in recent years and are worth a look.