Even when people work to make their money stretch as far as possible in retirement, they may look for ways to increase their monthly income. One option is an annuity, which provides a guaranteed income through monthly payments that last throughout an individual’s life. An annuity can help to cover any gap between Social Security and pension payments and the basic living expenses that individuals will have once they retire. This option can provide a number of benefits for people who want to ensure that they have enough monthly income once they retire, but there are also some clear risks involved with purchasing an annuity. Understanding the balance of risks and benefits can help individuals decide if this option is right for them.
Advantages of Investing in An Annuity
The primary advantage of an annuity is the fact that individuals cannot outlive the money, as the monthly payments come for the remainder of their lives and do not depend on the performance of the stock market or any other financial market. Having this income may prevent people from making poor investment decisions down the road, as it provides guaranteed payments. Furthermore, the payments are often higher than individuals might expect with low-risk investments like money market accounts, bonds, and certificates of deposit. Some people view having an annuity as a license to make more risky investments. After all, there is a certain level of income guaranteed and if more is not needed, then people can bet big for the potential to generate higher returns without putting their financial security at risk.
Of course, annuities are only guaranteed so long as the issuing body remains in business, although many times a state guaranty association will protect against insolvency up to a certain limit. Most limits sit between $100,000 and $300,000 per owner, so the protection is not absolute, but it can help to make such a situation less stressful for annuity owners. However, individuals much invest quite a bit of money into an annuity. People will get about $500 in monthly payments once they turn 65 for each $100,000 that they commit to annuities. In some cases, this investment can make sense, but it often means tying up a lot of money up front without a lot of liquidity in the event that an investor needs to use it to address an emergency down the line.
The issue that many retirees have with an annuity is the fact that it is tied to a single person, which means that heirs do not always continue to receive payments. Some annuities will offer options that allow other people to continue benefiting down the line, but the money does not automatically pass on to heirs, which can give some people pause. Another issue that comes with annuities is interest rate risk. The payout depends on the current interest rate, so people who purchase at the wrong time may become locked into a lower payment with little or no ability to make adjustments. Individuals should always understand the terms of an annuity before signing paperwork, including what happens to the investment if the issuer goes bankrupt.
Key Considerations When Deciding on a Particular Annuity
Once individuals see the various pros and cons of purchasing an annuity, the next step is to learn about the different types of investments that exist and choose the best one. Most retirees opt for a single premium immediate annuity, which some may call an immediate fixed annuity. This version of the annuity comes with a monthly payment that starts shortly after it is purchased, although the purchase price must be paid as a lump sum. This type of annuity provides fixed payments that do not fluctuate with the stock market. Another basic type of annuity is the variable one, which is tied to the performance of certain investments. This option provides less stability than the other type of annuity, but it could also lead to increased payments over time.
Life Expectancy a Factor
The other factor that comes into play is the life expectancy of the individuals who take out the investment. In general, equivalent men and women will get different monthly returns for the same investment, which is because women have a longer life expectancy. If a couple takes out an annuity together, the monthly payment is even less because the joint option means that the investment continues to pay until neither party is alive. The payment can be higher if a couple chooses to have a reduced payment once the first individual dies. On that same token, monthly payments will typically be higher if individuals take them on later in life.
Opting for any sort of extras with the investment will also typically reduce the payment. For example, couples can take out a joint life policy with 10-year certain, which means that beneficiaries will receive monthly payments in the event that both parties die within the 10-year period. Another option is a cash refund, which provides a lump sum that is equal to the original investment to any heirs with the payments received subtracted from that total. Investors can also often choose inflation protection for their monthly payments. While this option will result in significantly smaller payments upfront, the payments will increase over time, which can help in managing finances later on in retirement.