Wednesday, September 24, 2014

How to Choose an Annuity for Retirement Income

How can you guarantee that you will not run out of your retirement savings before you die?  One idea that is recommended by many financial advisers is to put a portion of your savings into an annuity.  Doing this can insure that you will always have at least some reliable income in addition to your Social Security benefits.  While not everyone will want an annuity because their assets are permanently tied up, others appreciate the secure income flow that annuities can create with a higher return than you would receive from bank interest.

In a "Money" magazine article, "The One Retirement Move You Must Get Right," the author discusses how to transition from saving for retirement to receiving a lifetime income from your savings.  As part of this article, the author demonstrates how you can lock-in a lifetime income with an annuity.  While they do not recommend doing this with all the proceeds of your 401(k) or IRA, they do see it as one part of a well-designed investment plan.  Which type of annuity is right for you ... a variable annuity or an immediate annuity?

Variable Annuities

Investment advisers who work for insurance companies are likely to advise you to purchase a variable annuity.  These investment products combine an income with the potential for your investments to continue to grow.  Approximately 75% of the annuities that are sold in the United States are variable annuities, primarily because the potential for asset growth sounds so appealing.

The downside of variable annuities is that the guaranteed income is lower and you may pay an extra 2% or more (6% vs. 4%) in up-front commissions as well as management fees of 2% or more per year of assets under management.  If you still decide that this is the best type of annuity for you, try to find one that only charges 1.5% a year for the assets under management.  If you pay 2.5% or more, you are unlikely to have enough asset appreciation to make the lower earnings worthwhile.

Fixed or Immediate Annuities

"Money" magazine suggests that most people will do better with a simple fixed or immediate annuity.  With this type of annuity, you pay a lump sum up front and receive a guaranteed lifetime income.   One advantage is that the commissions are usually 4% or less, compared with 6% for a variable annuity.  In addition, you do not pay the 2% annual management fee.  You can compare the commissions and estimated earnings for various fixed annuities at a website called immediate-annuities.com.

Rather than relying on the potential of appreciation in a variable annuity, with a fixed annuity you can put a portion of your retirement savings into the annuity and then invest the remainder of your savings in a low-cost mutual fund or exchange traded fund.  Research has shown that people tend to do better with this combination than they do when they put everything into a variable annuity.

Whichever type of annuity you choose, you will not want to rely solely on annuities for all of your retirement planning.  The more diverse your portfolio and the types of retirement tools you are using, the fewer problems you will have during a stock market decline, such as the one that began in 2007.

You may also want to read these other posts that were based on the Money magazine article:

Should You Rollover Your 401(k) Into an IRA?
How to Choose a Good Investment Adviser

Source:

"The One Retirement Move You Must Get Right," Money Magazine, July 2014, page 44.

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