Posted by LLOYD J CAZES CPA

Annuities 101: Fixed Annuities Can Stretch Your Retirement Savings

Annuities 101: Fixed Annuities Can Stretch Your Retirement Savings

An annuity is a lifetime income that guarantees that you buy from an insurance company and also to reduce the risk that you run out of money in retirement. Similar to the way you ensure your home, you can protect your longevity by passing on the chance that you live beyond your savings to an insurance company.

There are many ways to fund an annuity — years before retirement, at retirement, over time, etc. — but they all provide you with the same thing: a guaranteed, steady lifetime-income stream when you retire that simplifies your retirement spending and offers peace of mind that you will not outlive your savings.

It is a discouraging challenge to manage investment and assets in retirement. It is hard accessing market performance on a long term, and in retirement, the time horizon is less than throughout accumulation years, hence enlarging risk. While working, you can offset losses with new capital from wages and employer matching. In retirement, a time when you want to be spending down savings.

Result:

Annuities are increasing in popularity. Annuities are delivered and controlled as insurance products, not investments. Annuities accounted for nearly $115 billion of all life insurance enterprise in the Americas,  from almost $60 billion in the five year period that came to an end in 2017.

How do they work?

Premium payments could be spread across months and years or paid in one slump; retirees get a guaranteed expected amount, usually every month. To simply state, the fixed income annuity looks like a salary, rather than by an employee; they are paid out by a financial institution. The financial institution must manage investments behind the scenes to realize that payment. Rather than depend on the market to reward your investment intuition in a defined contribution plan like a 401(k), the annuity issuer pays a fixed amount that is more like receiving a paycheck. And even if you live beyond your life expectancy, you will continually earn a steady income. Annuities are in different configurations. 

Single-premium immediate annuities: This type of annuity is the easiest to explain. In exchange for a single lump sum carried out by the buyer, the annuity begins paying benefits that same month.

Fixed indexed annuities: This type of annuities link returns to both a minimum guaranteed interest rate and a broad stock market. So when that index goes well, holders get more interest. In a situation when the index dips, interest can’t go below the guaranteed rate. It allows investors to seek higher returns on an annuity purchase without downside volatility.

Deferred annuities: It is also known as longevity annuities, this structure typically does not pay benefits until several years after premiums fully paid. The buyer has an advantage of a lower premium cost than an immediate annuity with equal interest. The insurer's position is the ability to spread risk across a more extended period before making monthly benefits to a policyholder.

The Biggest Planning Obstacle: Time 

Fixed income annuities minimize uncertainty by protecting recipients from market fluctuations as well as guaranteeing a constant stream of payments until death. Rather than trying to predict the proper amount of principal to withdraw in a particular year, they provide income the retirement. 

It is in these advanced years when many starts to doubt whether their retirement asset mix and spend-down are fitting and if they will be adequately rewarded for taking a chance in the market. Volatility is not always bad. But it is terrible when you are not compensated for more risky investments.  

Research by the Employee Benefit Research Institute discovered that, on average, committing up to 20% of a 401(k) balance to a deferred income annuity of 20 years at 65 years of age enhancing retirement asset outcomes. Higher wage earners do better with higher percentages committed to the annuity, at levels up to 30% of the 401(k) balance, because Social Security is more generous for the lower-wage earners.

Don’t Forget To Spend Your Money  

Fixed income annuities can also assist retirement investors in dealing with a less visible risk: that of not spending enough in retirement. About retirement spending and annuity purchases, Suzanne Shu observed that some of the most significant mistakes made in retirement does not revolve around lack of assets but involuntarily spending too little. Some retirees are scared of spending down their nest egg and are not aware of what to do.

Commitment to the buy of a fixed income annuity can make available a psychological signal to spend without fear of quickly running out of assets. A decision to hand over the [premium] to buy the annuity is big. But once accomplished, most of your fears and concerns are resolved because you have got guaranteed income every month.

It is a complicated decision to Purchase a fixed income annuity, and investors will have different priorities and aim around their in-retirement spending and benefits for surviving spouses or other beneficiaries. Hence, few investors commit all of their savings to these products. 

LLOYD J CAZES CPA
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