June 25, 2014 by Jocelyn Black Hodes
If you’d retired, or were planning to, around 2008 you
probably found yourself in big trouble.
When the stock market crashed, many people saw their
hard-earned retirement nest eggs lose 35 to 40% of their value in what seemed
like a blink of the eye. Ouch. For those nearing retirement age, that meant a
serious revision of their retirement plan and serious doubts about the 4%
withdrawal rule.
This rule, which was believed to be fail-safe for years,
claims that withdrawing 4% of your savings during the first year of retirement
and increasing that dollar amount by 3% in each subsequent year to keep up with
inflation would prevent you from running out of money for 30 years. Now, even
the seemingly conservative 4% withdrawal rule is probably too risky. Is the
dream of “guaranteed income for life” just a dream? Maybe not.
One solution is to work longer, or you can significantly
scale back your lifestyle in retirement and make do with less. Another
solution? Consider supplementing your retirement savings portfolio with an
annuity. Since 2008, more financial experts are praising annuities, combined
with a well-diversified portfolio, as possibly the best strategy to hedge
longevity. (And since women live longer than men, that’s a particular concern
for us.)
An annuity is a contract between you and an insurance
company that can provide you with a reliable income stream for a certain period
in exchange for a lump-sum investment or series of investments.
There are three main types of annuities: fixed, indexed, and
variable. Depending on your timing and income needs, you may choose an immediate
annuity, which begins paying income ASAP, or a deferred annuity, which gives
you the ability to grow your investment account and income potential.
In a fixed annuity, you get a guaranteed rate of return
based on current interest rates and periodic payments in a fixed amount based
on your account value at the time you decide to receive income. These payments
can last a certain amount of time, like 20 years, or for life or the lives of
you and your spouse. The longer the payments are set to last, the less the
payment amount will be.
An indexed annuity gives you the chance of earning a greater
return than a fixed annuity typically based on the performance of the S&P
500 index. However, that greater return is capped and is usually no more than
8%. Indexed annuities also guarantee a minimum contract value, regardless of
index performance.
A variable annuity gives you the option of investing your
payments in the market (typically mutual funds) and earning an unlimited
return. However, you can also lose money based on how your investments perform,
and just as your rate of return varies, your income will as well.
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Annuities often include a death benefit and a variety of
other optional features, for added fees. Variable annuities offer “living
benefits” that can include protecting your account from losing value,
guaranteeing your minimum payment, and allowing large withdrawals without
penalty (many annuities come with a “surrender period” during which you would
have to pay a penalty fee to withdraw your money). The more features you get in
a contract, the more you will pay in fees that will reduce your account
performance.
For someone in retirement or close to it, an immediate
annuity could be a smart way to protect yourself from outliving your money and
from market risk. Just keep in mind that choosing an immediate annuity means
giving up control of your investment, so you need to be prepared to make that
sacrifice.
If you’re at least 10 years away from retirement, a variable
annuity could make sense, but only if you are in the small minority of people
maxing out all other tax-deferred retirement plans. While annuities in general
are complex products and require thorough research and education, variable
annuities tend to be the most confusing and fee-heavy.
Unfortunately, annuities have a history of being sold by
agents who are eager to make big commissions and do not explain them as well as
they should and disclose all of the restrictions and costs upfront. So make
sure you do your homework, shop around, and ask lots of questions.
Bottom line: In today’s world of disappearing company
pensions, questionable Social Security and market volatility, annuities are
powerful tools that should be seriously considered as part of anyone’s
retirement plan.
Jocelyn Black Hodes is DailyWorth’s resident financial
adviser.
The story “What is
an annuity?”originally appeared on Dailyworth.com.
Originally Posted at MarketWatch on June 24, 2014 by Jocelyn Black Hodes.
Categories: Industry Articles
