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 often 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. Many financial planners have noticed that a growing number of people are buying annuities in the early 50s and a Gallup survey of owners of individual annuity contracts has found that nearly four in 10 annuity owners buy their first annuity when they are younger than 50.
Concomitantly, the Gallup survey also found that the number of folks buying their first annuity at 65 or older has been falling.
A more recent Gallup survey, published in 2018, found that 85 percent of non-retired U.S. investors strongly agree that it’s important to have a guaranteed income stream in retirement to supplement Social Security. The survey said “only 27 percent” strongly agree they’re willing to give up access to some of their money to build that guarantee, suggesting they’re mostly not sufficiently committed to strengthening their retirement finances.
But this number is pretty good when you consider that a surprisingly large number of folks are willing to sacrifice some financial freedom today for tomorrow in a country not known for a particularly strong savings ethic. According to the Organization for Economic Cooperation and Development, the U.S. ranks only 15th among 34 OECD countries in the percentage of disposable income saved.
The reality is that while there is no perfect age for adding an annuity to a portfolio, if often dos make sense to do so at a younger age. In fact, some financial advisors believe that the mid to late 40s may be the sweet spot for the initial purchase of an annuity. The theory is that most people have fewer external demands on their earnings at that age, such as paying for college tuition, weddings, or helping a child purchase a home. Fewer bills to pay – albeit for a relatively short period of time – means that many 40-somethings can afford an annuity.
The trend toward younger buyers is highly likely to continue, especially after years of unusually strong gains in the stock market. History says this cannot last. Revision to the mean isn’t a bad thing, but many market pundits believe stocks won’t even do that because of rising inflation and interest rates. Some annuities, such as fixed income annuities, guarantee against losses, and others, such as structured annuities, are positioned so that owners can collect a premium to market performance.
Here are five factors explaining the movement toward annuities at a younger age:
- 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 so they’re looking for vehicles that provide a lifetime income stream, as many annuities do. The initial 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 this still-young century – 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 a growing number of people, the benefits of buying an annuity early outweigh the drawback of illiquidity and higher fees. Many annuities have rollups – annual increases in the income base as long as withdrawal is deferred– for up to 20 years – that increase payouts later. 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.
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 one financial planner familiar with annuities.
Needless to say, it doesn’t make sense for everybody to buy an annuity when they are relatively young. Many people simply can’t afford to do so. Others can’t justify it, and wisely, after they review all their income sources, now and later. If they’re in line for a relatively pension, for instance, an annuity at an early age – and perhaps any age — 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.
Yet 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 increasingly considered a smart decision
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