Annuities Give Retirees Freedom to Spend
The days of riding off into the sunset with a guaranteed pension paycheck and a gold watch are no longer a reality for most people.
According to CNN, the percentage of private sector workers with a traditional pension plan is 4% today compared to 60% back in the early 1980s. And the few remaining companies with pensions are eliminating their plans as soon as possible.
It is understandable because, with a traditional pension, the company is solely responsible for funding a monthly pension check for an unknown number of years. Whereas, with a 401k plan, the financial responsibility is mostly on the employee, who invests over the years, must choose among what CNN calls the “sometimes confusing array” of offered funds, and who will at retirement be expected to figure out how to make it last a retirement lifetime.
So, rather than a pension paycheck, today most people retire with a lump sum of money for which they are responsible to ensure that it lasts the rest of their lives. This poses a big problem for many retirees who find themselves in this unenviable, critically important role.
Do you play it safe and try to only spend interest on the nest egg or use the money as it was intended and give yourself a dream retirement, but run the risk of running out of money?
The answer to this troubling question for some retirees may be to use some of that retirement savings to purchase an annuity that will guarantee income for life, which transfers the risk of living too long to an insurance company. It also offers you the confidence to spend the money you worked so hard to earn and enjoy your retirement.
Additionally, it may create a less stressful retirement by reducing the urge to focus time on following the movements of the sometimes rollercoaster stock market.
According to Michael Finke, a Professor at the American College of Financial Services, and David Blanchett, Head of Retirement Research at Prudential Financial Inc., guaranteed income gives retirees “a license to spend” because you no longer must look into the crystal ball to determine exactly how long you will live. It also gives you confidence that, even if you live to the ripe old age of Methuselah, you will not outlive your income.
Not only can annuities give retirees the freedom and confidence to spend their hard-earned money, but it may be with much less stress than the typical equity-only portfolio. It also alleviates the stress of adjusting spending on essentials when your living costs are covered by guaranteed income.
Further, annuities can transfer the risk of the sequence of returns to an insurance company. Sequence of returns risk is the risk that when the market is going down, drawing money out of an equity portfolio can increase the rate that the portfolio’s balance goes down.
This is because once the money is taken out it cannot be leveraged when the market recovers which is another large risk to retirees.
Or another way to think of it is increasing the rate of loss because as the market is going down, taking money out will further decrease the value of the account. And if this happens the person’s account may never recover.
Finke and Blanchett’s paper also says that people with guaranteed incomes spend twice as much as those living off an investment portfolio in retirement with the same amount of assets when they retire. This is partially because they are ensured a check for the rest of their lives and secondarily due to the fact that people do not want to see their portfolio balance going down after spending decades building the balance.
An annuity also takes the pressure off relying on market returns to determine how much you can spend each year in retirement.
So, the short of it is, people who are guaranteed a check for the rest of their lives can more easily budget and maximize their retirement lifestyle.
Annuities may be the answer to a retirement world with fewer and fewer pensions. Although annuities should not be the only investment for most retirees, they can play a role in giving retirees the confidence to spend money in retirement and maximize their retirement experience.
A retirement strategy to build your portfolio is a complex issue with a lot of variables to consider. It’s crucial to take your time to understand your options and make sure that you get it right for your specific situation.
If you’d like help planning your next steps, contact a certified financial planner at Medallion Financial Group today, and let’s have a conversation! Click here to schedule a free consultation.
About the Author
Daniel Searles is one of our newest Financial Advisors at Medallion Financial Group. Daniel earned his degree in Business and Marketing from the University of South Carolina at Beaufort. As soon as he achieved all his licenses, Daniel enrolled in the University of Georgia’s CFP program. Excited to be following in his father’s footsteps, Daniel is working hard to get fully credentialed. In what little free time that affords, he enjoys playing baseball, fishing and hunting, and playing with his nieces and nephew.
The guarantees of an annuity contract depend on the issuing company's claims-paying ability. Annuities have contract limitations, fees, and charges, including account and administrative fees, underlying investment management fees, mortality and expense fees, and charges for optional benefits. Most annuities have surrender fees that are usually highest if you take out the money in the initial years of the annuity contact. Withdrawals and income payments are taxed as ordinary income. If a withdrawal is made prior to age 59½, a 10% federal income tax penalty may apply (unless an exception applies).
At Medallion Financial Group, we believe financial planning is about Family. We have been helping families invest in the future since 1987 through a holistic planning approach. We recognize there are a variety of needs when it comes to retirement planning, plan rollovers, annuities, college planning, life insurance options, and investment management. It is easy to get lost in a sea of choices. Our financial advisors help with the basics and beyond to enable our clients to get the education, advice and management they need to retire with confidence.
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