Over the course of our working life, we gradually save for and build up a pension pot to support our lives in retirement. At some point before retirement or during the first few years, you can use your savings to buy an annuity from an insurer. The insurer invests your money and promises to pay you a regular income for the remainder of your life, either commencing immediately or in the future.

At face value, annuities sound like a smart investment plan. However, are they a good idea for your retirement?

When Annuities Good Investment?

You’re a high-income earner in a high tax bracket
Annuities are an attractive option for high-income earners because they offer the ability to build tax-deferred savings. For example, a low-cost variable annuity can be a smart investment if you’ve completely maxed out your 401(k) and simple IRA deferral contributions. Low-cost variable annuities charge as little as 1% per year. However, it’s important to consider what your income will in during retirement, as you may end up disappointed with your revenue as a result of buying an after-tax annuity that ends up in a higher tax bracket.

You’re worried about outliving your retirement savings
It’s a fact, we’re living longer, and with that comes the increased risk of out outliving our retirement funds. Preventing this from happening is one thing annuities do really well by providing a guaranteed stream of income for retirees for the remainder of their life. For the average employee, choosing a sound set of investments is incredibly challenging. With annuities, the insurance company deals with where to invest your money without you having to worry.           

You have a clear vision of how an annuity will help accomplish your retirement goals
An annuity can be a powerful investment tool when used for the right reasons and in the right situation. While many people choose to buy an annuity to guarantee a certain level of income for a period of time or the remainder of life, annuities can also be used to accumulate assets, provide a death benefit or cover long-term care costs.

If you have a clear investment goal, your retirement savings can be invested into an annuity to maximize returns, reduce risk and eliminate unnecessary fees, taxes and surcharges. However, to achieve this, you need to investigate the available options and alternatives, determine how much money is required to meet your goal and get a tight grasp on all the restrictions and fees of the annuity product, which can run as high as 3% a year. You will also want to compare the tax you’ll bare once payments begin and consider some ‘what-if’ scenarios.

When are Annuities a Bad Investment?
Annuities are not for everyone.

You already have enough assured income
When considering whether to buy an annuity, you need to ask yourself whether you actually need another source of income to live comfortably in retirement. Do you receive Social Security? If yes, then you already have an indexed annuity that provides income for the rest of your life. Do you have a pension as well? Then you now have two fixed annuities that provide a steady stream of income for the rest of your life.

So ask yourself: Do I need more guaranteed income than I’m already receiving or set to receive?  You can utilize the government’s Social Security Quick Calculator or more robust Retirement Estimator to determine whether your benefits will be enough to cover your retirement expenses.

You already have a sufficient retirement savings
Likewise, if you’ve managed to accumulate a significant amount for savings and have no need to worry about chewing through your money in retirement, even if you were to live another 100 years, then there’s really no need to invest in an annuity.

It doesn’t take into consideration your entire financial picture and goals
If a salesperson is convincing you to buy an annuity without having first looked at your entire financial picture, we recommended proceeding with caution. Just like all good investments, annuities should be carefully considered to ensure they coincide with your complete retirement plan. A salesperson cannot accurately forecast the associated fees and tax implications of the annuity they’re selling without thoroughly analyzing your current situation, and could ultimately end up diminishing your retirement income.

Your life expectancy is significantly reduced
The potential of passing away before collecting the full benefits of your investment is a legitimate concern facing any investor. If you have a health condition that is likely to dramatically reduce your lifespan, handing over your hard-earned savings to an insurer that promises a lifetime of payments may seem pointless. However, most people also take into consideration the life expectancy of their spouse and/or dependents.

If the deal seems too good to be true or is just plain confusing
While most annuity sellers mean well, they may also be influenced by a sizable commission for selling a variable annuity. If you’re looking at a fancy variable annuity that you really don’t understand, it’s best to seek a second opinion. Remember, no legal requirement stops commissioned salespeople putting their own interests before yours. You may be better off investing your retirement savings in a well-balanced portfolio of stocks and bonds.

Not all Annuities are Built the Same
Different annuities have varying degrees of risk, and each retirement plan has a different tolerance for risk. “Fixed” annuities are conservative options as they guarantee a fixed rate of return for a certain number of years and are not influenced by market trends, interests rates, and other variable factors. “Variable” annuities, however, fluctuate according to the rise and fall of the performance of the investment and thus represent a higher risk.

Before jumping into a final decision, shop around, do your homework and read up on alternatives. Annuities aren’t going anywhere fast, so don’t feel rushed into buying just because a sales representative tells you, “it’s only going to be available for a limited time.” While some insurance agencies may discontinue specific products, there’s no need to worry as a similar product will come around again soon.

Bottom line
An annuity can be a good idea if it is comprehensively planned and coordinated with your entire retirement plan and you understand its purpose and underlying terms.

If in doubt, please get it touch with us, and we will be more than happy to discuss your situation.