According to conventional wisdom, most people who buy annuities purchase them shortly before retirement. Many need to wait that long to accumulate the money required for purchase, the thinking goes. Regardless, what is the point of locking up the money and paying higher fees earlier than necessary?
As it turns out, it often does make sense to accept the illiquidity and fees at a younger age, and, in fact, more people are doing just that. The median age at which people buy their first annuity is declining, according to the Gallup Survey of Owners of Individual Annuity Contracts in 2013.
That survey, the latest of its type available, found that median age at first purchase of annuity was 52 — one year younger than it was in a Gallup survey in 2009 on the same topic. The 2013 Gallup survey also found that nearly four in 10 annuity buyers made their first purchase when they were younger than 50.
Another noteworthy finding was that the percentage of respondents who purchased their first annuity at age 65 or older fell by 8 percentage over four years – from 22 percent in 2009 to 14 percent in 2013.
Why the Young Are Turning To Annuities
The trend toward younger buyers is highly likely to continue as the stock market continues to follow a rocky path in the wake of one of the longest bull markets ever. Five factors explain the phenomenon:
- Increased public awareness about the importance of retirement planning, especially with doubts growing about the solvency of the Social Security system, say financial planners and others.
- People are living longer, and they’re looking for vehicles that provide a lifetime income stream, as most annuities do. The Gallup survey showed an increase of nine percentage points in the number of annuity owners who said that lifetime income was a key reason they bought an annuity.
- People increasingly are warming up to the fact that annuity earnings are not taxed until withdrawal. According to the Gallup survey, 70 percent of annuity owners say they have set aside more money for retirement than they would have if the tax advantages of annuities were not available.
- Two stock market crashes in the last 15 years – the first in 2000-2002 and the second in 2007 to 2009. Fewer people are willing to face the risk of becoming participants in a third crash.
- For some people, the benefits of buying an annuity early outweigh the drawback of illiquidity and higher fees. Many annuities have rollups – generous annual increases in the income base as long as withdrawal is deferred, for up to 20 years – that increase living benefits. In addition, deferred income annuities, which don’t pay benefits until a much later date, allow people to receive substantially higher living benefits for less. Generally, younger people can leave the money alone much longer than older people.
Building a Retirement Nest Egg Sooner, Not Later
What all this adds up to is that a good case can be made to use annuities to begin building your retirement nest egg sooner, rather than later, simultaneously staying clear of stock market vagaries. “The last thing you want to happen is lose a part of your nest egg prior to retiring and find out you have to work longer,” says David Smith, an Advisor at Somerset Wealth Strategies.
Needless to say, it doesn’t make sense for everybody to buy an annuity when they are relatively young, financial planners say. Many people simply can’t afford to do so. Others have to poke relatively carefully into personal finance details. If they have a relatively generous pension, buying an annuity makes little sense. Ditto if they or their spouse or both intend to work well beyond normal retirement age.
And, of course, younger people who may have to withdraw annuity funds early should avoid annuities because they would have to pay a 10 percent penalty before age 59 ½.
But for those who make the maximum annual contribution to their IRAs and 401(k) s and have a respectable emergency fund, buying an annuity early is an attractive proposition, says Scott Sadar, another executive vice president at Somerset Wealth Strategies. “There are more of these people than you might think,” Sadar says. “It’s a great way to accumulate retirement contract that will benefit you every year you are working.”
People in their 40s Best Positioned To Buy Annuities
People in their 40s may be in the best position of all to buy annuities, Sadar says, because they have fewer external demands on their savings or potential savings than they will later in life. At that age, for example, most people do not have children attending college. They will a decade later, however, and after that they will be looking at their children’s weddings and the chance that at least one child will move back home. And, too, they will have to start thinking about their long-term care expenses.
Sadar has one client who was 23 in 2009 when he bought his first annuity for $2,000. Since then, he has added an additional $2,000 in five of the last six years, all accumulating at an annual rollup rate of 6 percent. “He is young, but he is wise,” Sadar says. “He sees this as his retirement money.”
Younger people also benefit when they buy a deferred income annuity, which typically doesn’t make payments for one to two decades down the road or even longer. Most insurance companies let customers change the payout date and add funds during the lengthy wait, according to Limra, a trade association for retirement and insurance research.
DIAs Benefit Older Folks, Too
Even a relatively old person can benefit substantially from a deferred income annuity. For example, if a 55-year-old instead of a 65-year-old buys a typical DIA for $50,000 whose benefits kick in at age 85, he will get 50 percent more income — $3,800 a month.
For the relatively young, of course, those properly positioned financially can buy almost any annuity and reap huge dividends. A 40-year-old who buys the North American Charter 10 fixed indexed annuity for $100,000 and waits until 65 to take withdrawals would collect $1,748 a month. By contrast, a 62-year-old who bought the same annuity for $100,000 would receive only $642 a month at 65.
Buying an annuity while you are young, Sadar says, “gives you a good heads start on guaranteed income for life.” Who can argue with that?
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