Annuity sales continue to make headlines as more and more consumers add them to their retirement planning portfolios. For those familiar with the products, it comes as no surprise, especially knowing that guaranteed lifetime income provides a peace of mind in retirement that nothing else can. However, there are still many people who steer clear of annuities, usually because they just don’t understand them. While it’s true that these retirement products aren’t appropriate for everyone, some people are missing out on a great opportunity.
Could you be holding your retirement planning back because of a simple misunderstanding? Here’s a look at six misconceptions about annuities, as presented in a recent Yahoo Finance article.
Misconception #1: I don’t need an annuity because I already have retirement savings.
Many people believe that having an employer-sponsored retirement savings plan or IRA is enough and they don’t need an annuity. Often times, having both is actually the best plan.
“While you’re building your savings, adding a fixed annuity can reduce the market volatility in your portfolio because they don’t move up and down like bond funds or stock funds, so it adds some diversification along the way,” said Dan Keady, CFP, chief financial planning strategist at TIAA. “If they start putting a little money away in annuities, they could start building their future lifetime income, and we think that’s important.”
It is important to note that if you have access to a pension plan, you probably don’t need to add an annuity.
“If they have a very big pension plan along with Social Security, they could be in a spot where they really don’t need an annuity because they already have that guaranteed income,” Keady added.
Misconconception #2: I can’t afford to buy an annuity.
Annuities have a reputation for being very expensive and out of reach for many investors. The truth is you may have access to an annuity in your 401(k) or 403(b) plan.
“Then, typically the way they work is like any of the other investments you have,” Keady stated. “You pick what percent of your contributions you want to go into the annuity and how much you want to go into this mutual fund and so on, so it’s extraordinarily affordable, because there’s really no difference from the contributions that you’re already making to your retirement account. If you’re putting away $100 from every paycheck, you could choose to put $10 into that annuity within the plan.”
If you don’t have access to an annuity in your workplace retirement plan, affordable options on the retail market are available.
“The retail market is all over the place,” Keady mentioned. “When you go to purchase an annuity, there might be some companies where it costs $5,000, some $10,000, some $25,000 and some $100,000.
Misconception #3: Annuities don’t actually “pay off” in retirement.
Having an annuity can actually “pay off” in more ways than financially.
“The first thing I’ve seen in real life is confidence,” Keady added. “People who have a pension or annuity that’s paying them income that literally can’t run out, they become much more confident. There are benefits – before we get to the math – because of confidence.”
But then there’s also the financial aspect.
“A lot of people don’t understand that out of a fixed annuity, you can get a higher income than from bonds, the reason being the concept of risk pooling,” Keady stated. “When I retire and take an annuity payment some time in the future, it won’t just be me – it’s a whole pool of individuals. Some of those will live longer and some of those will live shorter, and that allows the insurance company to pay based on life expectancy. If you don’t use pooling, you really need to hold back.”
“You’ll often hear about the 4% rule, where you need to start lowering withdrawal rates,” he continued. “The more income from the annuity means I’m taking out less money from the remainder of my portfolio, which ultimately gives it the chance to grow. This concept of never running out in real life translates into the real life of freedom to spend. My experience is people who have pension payments and annuity payments never feel bad about spending those because they keep coming.”
Misconception #4: Annuities are worthless if I die early.
Many investors steer clear of annuities because they are concerned that they will pass away before the annuity reaches the distribution phase or shortly thereafter.
“Let’s say I have a pure annuity and I leave my spouse out of it. I create that annuity income and get hit by a bus the same day. That’s the fear you get from people – what happens if you pass away early?” Keady said. “The reality is that the individual or joint couple that’s taking the annuity can never lose because they’re getting their checks – the only people that could typically lose are the kids or the beneficiaries. They could get back something less. But in the real world, very few people are going to choose a pure life annuity where if they pass away early, there’s going to be nothing left.”
There are always add-on options, such as a joint-life option which provides payouts for the longer-living spouse or a refund feature that passes remaining payments to beneficiaries in the event you passed away early.
Misconception #5: I don’t need to buy an annuity because I’m still young.
Many younger investors believe that annuities are best suited for people in their 50s and 60s. This simply isn’t true.
“The reality is, like most things, you’re better off getting started early so that you could start accumulating for it,” Keady added.
Misconception #6: I don’t need an annuity because I can create lifetime income on my own.
“A lot of people say, ‘I know I need income for life, but I can do it on my own. I can create my own annuity,’” Keady stated. “And the reality is, you really can’t create your own annuity because you don’t know how long you’re going to live – that’s problem number one. And problem number two, the whole concept of [annuities is that] a whole bunch of people go in and are getting paid over time. You really can’t create your own annuity because the only product that guarantees lifetime income is an annuity.”
Written by Rachel Summit