Retiring with Annuities

Grandpa’s fixed pension—that sweet and steady stream of income that started on the day he retired—is nearing extinction. Today, most Americans will retire not on company checks but on personal savings and Social Security. With interest rates low, the stock market jumpy, and Congress pinching pennies, it is no surprise that 87 percent of us worry about running out of money, according to a new study conducted by Harris Interactive.

That worry helps explain the popularity of annuities, financial products designed to generate a steady cash flow as long as you live. But today’s annuities are very different from yesterday’s pensions, says Christopher Jones, CFP, principal of Las Vegas-based Sparrow Wealth Management: “They certainly are not for everyone, and choosing the right one is crucial.”

You buy an annuity by forking over a lump sum, and, in return, the annuity company agrees to pay you a set amount of cash each month for the rest of your life. Why annuities? Bonds generate steady dividends too, but you’ll get more monthly cash from the annuity. That’s because of something called the “mortality premium,” which is a polite way of saying that annuity providers will pay you more today because when you die they, not your heirs, will grab your principal. The mortality premium gets larger for every candle on your birthday cake. The very best candidates for an annuity are older (65+) and have expectations of living a good long time.

You are probably a good candidate for an annuity if…

You’re not certain you have enough money coming from Social Security and your savings to cover your basic expenses in retirement. Say you’ve crunched the numbers (see “What’s Your Retirement Number”) and have calculated that you’ll need to tap $1,000 every month from personal savings, but that’s really more than your nest egg can handle. Buying an annuity that pays out $1,000 a month will allow you to sleep at night.

You are probably a bad candidate for an annuity if…

You have a good-sized nest egg, are in little danger of running out of money, and can stomach a bit of market risk. “The return you’ll get on a diversified portfolio will very likely be much greater than what you’ll get on an annuity,” says Jones. In addition, your heirs—not the annuity company—will get your money when you pass away.

The standard annuity is a fixed-income annuity. To receive a guaranteed $1,000 a month, a fixed annuity today would cost a 65-year-old man roughly $165,000 (about $175,000 for a woman because women usually live longer). You may choose to purchase add-ons such as a “joint-and-survivor” benefit, which allows your spouse to continue collecting if you die in exchange for reduced cash flow while you’re alive.

The other kind of annuity is called a variable annuity. Unlike the fixed annuity, this option ties your cash payments to underlying investments. The payout fluctuates, but you still get security. However, Jones warns that variable annuities, often pushed by aggressive salespeople, can be incredibly complex and expensive, and often don’t deliver as they promise.

Ready to start shopping? Kerry Pechter, publisher of the online newsletter Retirement Income Journal and author of Annuities for Dummies, offers the following tips and caveats:

• Buy only from a strong company. You may be around for several more decades; you want a company that will be around, too. Choose only companies with the very highest credit ratings. Ratings are listed on the websites of the providers.

• Compare offers. Prices change frequently, and during any given month the best deal might shift from one carrier to another. You can compare prices easily online. The following sites will give you competitive quotes from top-rated companies: Fidelity.com, ImmediateAnnuities.com, and IncomeSolutions.com (that last one is available only to customers of Vanguard and fee-only financial planners).

• If you are concerned about inflation (and you should be), don’t put all of your money into an annuity. Leave enough aside to invest in stocks or buy an annuity with inflation protection (which costs a bit more but adjusts annually to reflect cost-of-living increases).

• Because annuities pay you based on current interest rates, and interest rates are now very low, you might want to “ladder” your annuities by putting some money into an annuity today and buying another every year for several years.

• If you feel a bit lost, you might think about getting an unbiased expert to help. Consider a fee-only financial planner; find one at napfa.org.

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About the Author

Russell Wild, MBA

Russell Wild is the author or co-author of nearly two dozen nonfiction books, including most recently, Bond Investing for Dummies, Second Edition (Wiley, 2012), Exchange Traded Funds For Dummies, Second Edition (Wiley, 2012), One Year to An Organized Financial Life (Da Capo, 2010, co-authored with professional organizer Regina Leeds), Index Investing for Dummies (Wiley, 2009), and The Unofficial Guide to Getting a Divorce (Wiley, 2005; co-authored with ex-wife attorney Susan Ellis Wild). Wild is also a prolific magazine writer with more than 500 articles in major national magazines, including AARP The Magazine; AARP Bulletin; Consumer Reports, Details, The Huffington Post, Kiplinger’s, Maxim, Men's Journal, Health, Cosmopolitan, Real Simple, and The Saturday Evening Post. Wild's books and magazine articles have been reprinted or excerpted in Reader's Digest (on several occasions), Men's Health, New Woman, and in countless newspapers and websites. Most of his articles for consumer magazines have offered snappy, practical advice on personal finance, especially investing. He also contributes regularly to professional financial journals, such as Financial Planning, Financial Advisor, The NAPFA Advisor, and Wealth Manager, and on occasion to custom publications, such as investor newsletters for Fidelity, Charles Schwab and Wells Fargo. Wild is formerly a senior editor in the book division of Rodale Press, and the founding editor of Men's Health Books. Way back when, he worked as a credit analyst at a large bank. In college, he studied economics, graduated magna cum laude, and went on to get a master's degree in business administration (MBA) in international management. In addition to his work as a writer and author, Wild is also a fee-only financial planner and investment advisor registered with the Pennsylvania Securities Commission. He is a long-standing member and past president of the American Society of Journalists and Authors (ASJA), as well as a member of the National Association of Personal Financial Advisors (NAPFA).