Should I Allocate Retirement Savings Into An Annuity?

Allocate Retirement Savings

Want to augment your retirement savings with a steady stream of income? You might want to consider devoting a portion of your savings into an annuity.

An annuity is a contract between you and an insurance company. You can make either a lump-sum payment or a series of payments. In return, you receive regular disbursements either within a month or at some time in the future. There are different types of annuities, but all fall under the two major categories: Deferred and Immediate.

With an Immediate Annuity, you can start receiving your payments within 30 days after your initial investment. A Deferred Annuity is different, however. Your money is invested for a period of time until you are ready to start receiving disbursements. Most deferred annuities are associated with retirement income. You can invest a lump sum or build up funds over time by contributing on a monthly basis. This way, you can then “annuitize” or convert, that amount into an income stream.

Many people ask whether it’s important to allocate their retirement savings into an annuity. Unless you opt to live an incredibly frugal lifestyle, it’s likely that you’ll need an annuity to meet your retirement income goals. Read on for why.

Why Do I Need An Annuity To Supplement My Retirement Savings?

The dream of every retiree is to maximize their lifetime income and reduce the risk of running out of money. First, define your preferred asset allocation. Think about how much to invest in stocks and bonds, and leave room for adjustments. The changes might involve taking a portion of your portfolio and investing in a Deferred Annuity.

Instead of retaining a portfolio mix of 40% stock and 60% bonds, you can adjust it to create room for Index annuities. Consider a portfolio comprised of 50-60% stocks/mutual funds, 30% Index Annuity, and then the difference in cash. Annuities are attractive to many investors because they provide a way to build tax-deferred savings. They also reduce the risk of running out of money by generating a steady flow of income.

Annuities Protect Your Retirement Savings

Just like a portfolio of stocks and bonds, annuities have the characteristics of standard investments. What sets them apart? Annuities come with insurance features. They help you reduce or transfer the risk of investing part of your portfolio to an insurer. Consequently, allocating some of your money to an annuity offers some insulation from the uncertainties surrounding the stock market.

Your primary goal is to have a guaranteed stream of income (more than what Social Security alone can provide) in retirement. Consider allocating some of your savings to an annuity. Research shows that investors who have an annuity tend to be happier in retirement. Annuities are a guaranteed pension-like income supply.

Do be careful when selecting your annuity. Some annuities come with high fees. These can cut your returns in the long run. Others charge penalties for early withdrawals and most of them are damn complicated.

How Much Of My Retirement Savings Should I Allocate To An Annuity?

No rule will tell you the percentage of one’s savings that should be put into an annuity.

Even if such a rule existed, you wouldn’t be obliged to follow it. The amount to save is based on a strategy tailored to your financial goals. To come up with such a strategy, you will first need to know how much your living expenses will be during retirement.

Start by drafting a retirement budget. There are some online tools such as BlackRocks Retirement Expense Worksheet. You can use this to estimate what your retirement expenses will approximately be.

Next, determine how much of your expenses can be paid from your pension and Social Security. Say your pension and Social Security payments are enough to meet all of your retirement expenses. You may not need additional income from an annuity. The withdrawals from your nest egg should be enough to cater for all your living expenses.

However, if you find a huge gap between your living expenses and what pensions and Social Security will pay, then you should consider devoting some of your savings to an annuity. You can use this retirement income calculator from T. Rowe Price to gauge how long your income might last at different withdrawal rates.

What Kind Of Annuity Is Best For Me

If you decide to allocate some of your savings to an annuity, the next question that needs solving is whether to invest in a fixed or a variable annuity.

With fixed annuities, the backing insurance company agrees to pay the investor a fixed rate of interest for the first year. Thereafter, the company can raise or lower the rate but not below a guaranteed minimum. Better even, fixed annuity interest is not taxed until you withdraw the money. Should you choose to withdraw the interest earnings before age 59 1/2, you will pay not only the tax but also a 10% penalty. Upon reaching the age of 59 1/2, you can withdraw 10% of the fixed annuity amount without any penalty. Any withdrawal above 10% of the account’s value could result in a surrender charge payable to the insurance company.

A variable annuity, on the other hand, works like a mutual fund. You can invest in multiple ‘subaccounts’ which can own stocks or a combination of mutual funds and bonds. Unlike fixed annuities, variable annuities have no guaranteed returns because the principal is invested in multiple subaccounts comprising mainly of mutual funds and money market instruments.

Therefore, you get to decide how you want your premiums invested as well as how much risk you are willing to take.

It’s also important to note that subaccount values fluctuate with changes in market conditions. This means that with variable annuities, the principal may be worth less or more than the original amount invested. If you are wary of market fluctuations, you might consider investing in fixed annuities as you can never lose the principal (guaranteed) unless the insurance company fails.

Annuities Can Supplement Your Retirement Savings With Income For Life

Note that the amount you get depends on many factors such as age, the amount you invest, and interest rates.

Despite all their benefits, it’s important first to weigh all the pros and cons to determine whether annuities are your best investment options.

Before investing, it’s advisable to take the advice of an unbiased professional who knows the pros and cons of annuities and other financial instruments.

Why Invest in Annuities? Because The Exclusion Ratios Means Tax-Exempt ROI

Why Invest in Annuities?

Exclusion ratios are tax-exempt portions of your annuity return. For example, each annuity payment you receive can be split into two distinct parts. The annuity investment capital is one portion. The other portion is an additional amount that is taxed at the current income rate. This portion is interest that you’ve earned. Consequently, it’s taxed as regular income would be. The capital portion of the return is not taxed. The return on capital, or the additional balance after the principal capital is subtracted, is taxed. This is because it’s considered part of the annuitant’s gross income.

What Is The Exclusion Ratio?

The exclusion ratio is a calculable ratio used to identify the portion payout that is excluded from taxable income. The exclusion ratio is the amount that the annuitant invested into the annuity divided by the return expected from the investment. Apply this exclusion ratio to each annuity payout. Now, identify the percentage of each return that is tax-free. Do not consider it part of gross income.

For example, say that an annuitant invests $158,000 into an annuity. The potential income stream based on life expectancy could be $264,000. The exclusion ratio would be $158,000 / $264,000, or 60%. The tax-exempt portion of a $1,250 per month payment would then be $750. The remaining $500 balance would be taxable as additional gross income.

Take the below as a more realistic representation of the exclusion ratio:

**This is strictly hypothetical. Any illustration you get from an advisor will show exact numbers.

What Is The Benefit of The Exclusion Ratio For The Annuitant?

You don’t need to add the tax-exempt return to your W2 or tax return during tax season. It’s completely exempt from gross income taxation.

Annuities calculate the payout based on the life expectancy of the annuitant. Consequently, requirements do apply for these types of investments. Use IRS tables to determine the total expected value. Different tax exempt rules apply to those annuitants who have retirement plans under the IRS public school employment laws which may allow the annuitant to have a greater amount of tax exemptions from an annuity.

How to Get Guaranteed Retirement Income for Life

Retirement Income for Life

Hitting retirement and having no guaranteed income can be detrimental to your health.

According to the American Psychological Association, older individuals with lower socio-economic status are at risk for increased mortality rates, higher stroke incidence, higher progressive chronic kidney disease, and lower health-related quality of life.

So, having a secure way to receive a steady income after retirement will help you live a full life.

But how do you go about doing that? How do you get guaranteed retirement income for life right now?

Well, we’re here to talk about how you can get a guaranteed income stream with an annuity and avoid the scammers because they are out there. So, let’s dig in.

How Does An Immediate Annuity Work?

A single premium immediate annuity (SPIA) is probably what you’re thinking of when you think guaranteed income for life.

You might be on the cusp of retirement, and worried about your income needs.

A SPIA allows your to start receiving income right away. It’s an agreement with your insurance company that allows you a guaranteed stream of income

Your insurance company will then calculate your monthly income based on a few things.

The type of annuity you purchased
The insurance company, each one prices these different and you should shop this around
Your life expectancy based on your age and gender
And the term of the annuity you’ve chosen, how long you would like your income stream gauranteed for

Your Choices When It Comes to Immediate Annuity Income for Life

Inflation can happen. It’s a risk you take when investing in pretty much anything.

But you can have your insurance carrier give you a variable payout in case of inflation.

It really depends on if you want to maximize your payment now or not.

A fixed payout will give you the most income today. But a variable payout will mean having to do with less right now. If you are retiring soon, this might be the right option as you have some income from your current job still trickling in. I would suggest looking at index annuities with a life time income rider if you would like rising income.

If you do go with a variable payout/rising income option it will most likely be tied to a stock market index with a minimum guaranteed amount.

The purpose of an annuity is to minimize risk. So go over the options and see which options will help you have guaranteed income for life.

What Are the Variables and Terms of an Immediate Annuity?

A term in insurance speak is the amount of time your guaranteed annuity income will last.

You can specify the number of years the annuity will last. This may not give you guaranteed income for life.

The life annuity will provide you income for life. This means, of course, for as long as you, and you alone shall live.

There are joint-life annuities. If you are married, a joint-life annuity option might be best.

If one spouse dies, the annuity continues to be paid to the surviving spouse.

What Variables Depend on Age And Gender?

This essentially affects your payout amount.

Of people over 100 years old, 85% are women.

Essentially, women live longer than men on average. And insurance companies take this into account.

They typically pay out LESS for women than men because of the life expectancy gap.

What Are Typical Rates for Immediate Annuities?

If you’re looking at obtaining guaranteed income for life through an annuity, then you probably want to know the rates.

Remember, you’re buying an annuity for income guarantees, then returns become secondary.

If you want higher returns, you have to take risks. And risks could leave you broke.

But, even with a guaranteed annuity, the longer you live the greater the returns.

So, don’t compare the payout rate or calculated rate of return on an immediate annuity to compare this to any other kinds of investments.

Instead, the rate you’re looking at should be used for comparison between annuities at different insurance companies.

One of the benefits of an immediate annuity is that any other capital you don’t use to buy the annuity can go to other investments.

In essence, you can build your wealth with an annuity coupled with other investments.

And the security it affords can’t be measured in the monetary rate of return estimates.

Immediate Annuities Are Only a Portion of Retirement Savings Income

This is not meant to be all the income you receive during retirement.

If you calculate the annuity rate you will receive, you will only get $558 dollars a month if you are age 65, male, live in Tennessee, and purchase the annuity for $100,000.

That’s maybe enough to buy groceries and maybe pay a bill or two.

If you want the highest payment, you will have to give up access to the 100,000 you put in.

You will want to have a diversified portfolio of ETFs and mutual fund and such to maintain your standard of living.

You might have guaranteed income for life, but that’s more of a safety net to ensure survival if other investments fail.

Again, this is more about peace of mind than returns or riches. Although, it can help you increase your wealth in the long run.

Be Careful When Buying an Annuity: Watch For Scams

You might be tempted to go with the insurance company that offers the highest payout.

Don’t. You need to do your research.

You will depend on the insurance company to remain good on their word when it comes to guaranteed income for life.

They must have an AM BEST rating of A- or better when it comes to financial strength ratings.

Only a fraction of the companies out there will give you the best deal and have your interests in mind. All the others are either not worth looking at or are downright scams.

Payouts between companies can vary widely. So make sure you compare your options and choose wisely.

The Bottom Line On Guaranteed Income for Life

If you’re about to hit retirement, you probably do want that safety net of guaranteed income.

You probably want to get an annuity with the right companies that will take care of you. And you probably want to mitigate the risk of not having an income after retirement.

If you do want these things, sign up for a free consultation to get more information on how to find the right annuity for you.