As Baby Boomers continue retiring in large numbers each year, many have long worried about how financially prepared members of that generation are to provide for their golden years. Given the challenges of figuring out how to invest to make a nest egg last for a retirement that could span 30 or more years, Baby Boomers need answers and advice on the most efficient ways to draw their assets. There is so much marketing geared towards specific products and strategies to solve their retirement income needs that makes choosing the right path difficult to say the least.
Generally speaking, I’m leery of investments with the word "income" in them. Income funds tend to be too risky for someone who wants to generate an income stream for themselves. Fund managers often chase high-yield bonds and high dividend-paying stocks in order to get the highest return.
High-yield bonds haven’t done very well lately and high dividend-paying stocks tend to come from a narrow sector or sectors which increases market risk. The other issue at hand is common assumption of the “four percent rule.” Studies show that the rule may lead to failure or leave too much money unused. Retirement planning is too complex to be summarized by a simple rule of thumb.
With all of these options vying for a spot in your financial plan, consider another way to establish steady retirement income while countering longevity risk. Part of the solution may lie in annuities. (For related reading, see: How Annuities Can Boost Your Retirement Confidence)
What Annuities Can Do
I’m an advocate of using annuities to create a self-funded pension. An annuity is an insurance product that pays out income and allows you to receive a steady income stream in retirement. The biggest advantage of annuities is that you can put away larger amounts of after-tax money and defer paying taxes on the interest. They are generally structured as either fixed or variable. I typically discourage the use of variable annuities as the fees are far too high on most (around 3.5% per year). Additionally, the contracts are very confusing — the choice of funds are too limited, many don’t allow for spousal continuation, and some companies have actually been able to change the contract after it has already been issued.
One type of these financial vehicles that makes a lot of sense is an immediate annuity. Immediate annuities have several advantages because you have don’t have to worry about market fluctuations for the necessary portion of your income. These annuities offer income for life or for a set period of time (such as 10 or 15 years) or a combination, as in payments are set for life but are guaranteed to be paid out to your beneficiaries for a set number of years in case you pass away before the guarantee period. Immediate annuities start paying out right away, so these are helpful to people who are already in, or close to, retirement. With a fixed immediate annuity, you can secure an income stream for the rest of your life, or as long as you choose.
Some of the rules annuities operate under can be complex, so take the time to research how to utilize annuities effectively before jumping in. Comparison shopping is a must if you want owning an annuity to work out in your favor. Always look at several different annuities and their terms to compare payments and how much money you’ll need to set aside to pay for them. Make sure you consider all of your investment options and how much risk you’re willing to take in regards to the amount of return you want to see. Once you make your premium payment and start receiving income payments, the decision is difficult to retract and comes with some fees and risks. (For related reading, see: Why Retirement Optimism Is Slipping for Many Americans.)
Whether you’re choosing to invest in an annuity either before or during retirement, market changes have the ability to bring challenges to your plans. Always consider the strength, reputation and claims-paying ability of the company issuing the annuity. The income you will receive is only guaranteed as long as the underlying investments of the annuity hold up, and this can depend on the market conditions, but also on the long-term stability of a company.
Another element you can add to your annuity is an income rider. Someone who is within 10 years of retiring is probably hoping that the stock market will cooperate until it is time for them to retire. In a situation like this, it may be a good idea to have a portion of the retirement funds in a deferred annuity with an income rider. The basic idea is that the income rider, which comes with a cost of about one percent on average, would grow at a guaranteed rate, subject to the claims-paying ability of the insurance company, anywhere from five percent to seven percent compound interest. The benefit is that you won’t need to take on additional risk to generate a solid return from the market. The rest of the funds can be focused on aggressive growth; you won’t need to access much of it for income, and it will fight the inflation battle.
As with most financial planning strategies, there are some limitations and caveats to consider. While there are some annuity contracts that increase payments with inflation, the numbers aren’t that attractive earlier on. Most people take a decent hit initially for the privilege of an inflation fighting income stream throughout their retirement. It’s best to rely on market growth over the long-term for inflation protection.
Each individual has different needs and goals when it comes to investing and retirement. Annuities are not one-size-fits-all, so it’s important to do sufficient research or speak with a financial or retirement planner about your specific situation and goals before determining that annuities are the most viable option for you. With proper guidance and planning, an annuity can be an extremely useful tool when it comes to retirement planning — creating confidence and a relaxed and worry-free retirement with guaranteed lifetime income. (For related reading, see: How to Budget and Spend to Maximize Your Happiness.)
Ash Toumayants is the founder of Strong Tower Associates, and has spent over a decade helping hard working people across Pennsylvania plan for retirement and make sound financial choices. To learn more about Strong Tower Associates, please visit www.strongtowerpa.com.
Investment Advisory Services offered through Retirement Wealth Advisors, (RWA) a Registered Investment Advisor. Strong Tower Associates and RWA are not affiliated.
Annuity guarantees rely on the financial strength and claims-paying ability of the issuing insurer. Any comments regarding safe and secure investments, and guaranteed income streams refer only to fixed insurance products. They do not refer, in any way to securities or investment advisory products. Fixed Insurance and Annuity product guarantees are subject to the claims-paying ability of the issuing company and are not offered by Retirement Wealth Advisors.