Moliciero Financial | Investing and Financial Planning

Lifetime Annuities Explained

A lifetime annuities explained is an agreement between an individual and an insurance company that, for a lump sum payment, the individual will receive an income for life. They are also sometimes referred to as immediate or income annuities. How much is received and whether it fluctuates over time depends on how the annuity contract is structured; but by definition, the individual cannot outlive his money. Lifetime annuities can be a very attractive option for those with longevity in their genes. If a family has ancestors who have lived into their 90’s and beyond, this is a way to ensure financial needs will be met, no matter how long one lives.

Since individual retirees have a diverse set of needs, it stands to reason that the lifetime annuities available are diverse as well. There are many options and riders that can be added to a lifetime annuity contract, designed to give the most flexibility possible to an individual in retirement. Lifetime annuities can be very simple as well, involving a single lump sum payment and regularly scheduled disbursements for life. Let’s look at some of the different types of lifetime annuities and how they work.

Types of Lifetime Annuities

A fixed lifetime annuity is perhaps the simplest type to understand. In exchange for the initial deposit, fixed payments are made monthly to the recipient for life. For additional cost, a spouse can be added and the annuity would extend to that person’s life as well. The interest rate that a fixed lifetime annuity earns is related to when the annuity is purchased, and can therefore be highly dependent on the economic conditions at the time. Often, a fixed lifetime annuity is not the best choice available.

An indexed lifetime annuity uses an underlying equity index such as the S&P 500, DJIA or Russell 1000 to determine the amount paid to the annuity holder. An indexed annuity is more complex than a fixed annuity, and often places rate caps on the amount of interest an annuity can earn. On the other hand, there is usually a guaranteed minimum amount of interest paid into this type of lifetime annuity, regardless of whether the index was positive on the year or not.

An alternative to the fixed and indexed type of annuity is the variable lifetime annuity. Variable annuities use investment in mutual funds to grow the value of the annuity over time. An advantage to this type of lifetime annuity is that the capital within the account can be invested in riskier but higher interest earning funds, ultimately paying the annuity holder higher returns. Since the responsibility for investment decisions is on the investor and not the issuer, this is a riskier type of lifetime annuity. Over time however, variable lifetime annuities tend to perform better than the other types.

Options and Riders for Lifetime Annuities

Lifetime annuities can be tailored to meet the needs of most retirees, since insurance companies offer many options and extra provisions that may be added to standard lifetime annuities. One such option or rider that may be added to a lifetime annuity is the coverage of a spouse. In the case of a typical lifetime annuity, the benefits cease when the annuity holder dies. With what are called joint-and-survivor annuities, the benefits will transfer to the surviving spouse, for the remainder of that person’s life. Since this type of benefit has the potential of costing more, an issuer will charge more for this provision in the contract.

Another option for lifetime annuities is inflation protection. Since indexed lifetime annuities adjust with market fluctuations and economic conditions, inflation protection does not apply to this type of annuity. Inflation protection is typically used as a provision in fixed lifetime annuity contracts. In this situation, payments may be structured to increase by a certain percentage over time, or they may be tied to the Consume Price Index (CPI), and adjust with fluctuations in that metric.

Since lifetime annuities are intended for retirement-aged individuals, there will most likely be no early withdrawal fees levied by the IRS. However, there may be fees and surrender charges issued by the insurer if the money is withdrawn from the account before maturity. If an annuity will be kept in place for a long time, choose the longest duration maturity available. Usually, even with long maturity annuities, after 7 years there is no surrender charge applied. Surrender charges apply only to withdrawals of capital; disbursements to the annuity holder are not subject to surrender fees, and they begin as soon as qualifications are met.

Other Advantages of Lifetime Annuities

Perhaps the biggest draw for lifetime annuity investors is the security and stability that they provide. When an individual invests in a lifetime annuity, the company providing that annuity is contractually obligated to making payments for the life of the holder, regardless of how long that may be. For a retiree who hopes to live a long and financially secure life, this is quite a guarantee.

Since lifetime annuities are sold through most insurance companies, it is easy to compare different plans side by side. And since a large number of insurers have been providing benefits for many decades, the records for performance are easy to track. For stability, security, and ease of comparison and purchase, lifetime annuities are one of the best retirement plans around.

Understanding Indexed Annuities

Indexed annuities are a type of annuity that derives its value from the performance of an underlying index. There are indexed annuities that track a variety of indices, with the S&P 500, DJIA and Russell 1000 among the most common. Also called equity-indexed annuities, these are somewhat conservative investment vehicles for people who want guaranteed income in retirement, but also want to participate in stock market advances. Indexed annuities are seen as the best of both worlds when it comes to safe returns on investment, while still growing capital.

A History of Indexed Annuities

Indexed annuities were introduced in the 1990’s as an alternative to the standard fixed or variable annuities that were the norm. They gained in popularity as the bull market run in equities continued through the latter half of that decade. In 2004, sales of indexed annuities topped $25 billion and by the end of 2009 they approached $200 billion in annual sales. As baby boomers enter retirement age, the popularity of these instruments continues to grow.

Indexed annuities are considered somewhat conservative, because the money in these accounts seldom decreases. Most issuers of indexed annuities offer a guaranteed rate of return on an annual basis, regardless of the performance of the underlying index. This guaranteed payment is usually nominal, between 1% and 3%; but in years when the market performs poorly, the relative gain can be quite attractive.

Participation Rates, Spreads and Caps

In return for the promise of not losing money, issuers of this type of annuity generally pay only a percentage of the overall gain made by the index in winning years. This percentage is called the participation rate. In doing so, the issuer is able to reclaim losses from down years and in effect, smooth out returns over the long term. The participation rate for an indexed annuity is the multiplier for how much the account will gain, relative to its index. A participation rate of 70% means that if the index gains 10% for the year, the account will be credited 7% for that period.

Another method used by issuers of indexed annuities for paying returns that are less than the actual amount gained, is called a spread. The spread is the difference between what an index gains and what is credited to the annuity account. Typical spreads for indexed annuities range from 2% to 5%. So, in a year where the underlying index registers a 12% gain, the annuity holder can expect to receive between a 7% and 10% return.

In addition to the participation rate and spread, many issuers of indexed annuities place a cap on the gains that can be made in any annual earning period. This cap can be a fixed percentage, above which the issuer keeps all profit; or it can be a graduated range based on market performance. This type of interest cap protects an issuer in years of far greater than average returns in the index, and allows for payments to be made during down years. Typical fixed caps on an indexed annuity are between 6% and 9%. Graduated caps can be as high as 12% or greater during very good market years.

Tax Treatment of Indexed Annuities

The tax treatment of gains in an indexed annuity is identical to that of a fixed annuity. Taxes are deferred until the money is withdrawn from the account. Since annuities are typically meant to be used for retirement, the taxes paid when money is withdrawn will most likely be from within a lower tax bracket. Deferring taxes on earnings until retirement can be like earning an extra 1% to 3% on your money.

Some annuities allow for a small percentage to be withdrawn without fees from the issuer, but keep in mind that withdrawals made before age 59 ½ are still subject to penalties from the IRS. Excessive withdrawals made before the maturity date of the annuity are usually penalized with “surrender charges”. Many issuers of annuities however, allow for hardship withdrawals under certain circumstances. Withdrawals made that are related to nursing home expenses usually do not incur surrender charges or penalties by most issuers.

How to Buy Indexed Annuities

Indexed annuities can be purchased through making a lump sum payment, or through a series of scheduled payments. Making scheduled payments into an indexed annuity is the typical method for those planning to use the funds for retirement. The advantage of this type of participation is that when investment is made into the underlying index at regular intervals, the cost basis is normalized over time. By this method, an investor takes advantage of purchasing during both up and down periods, while participating in the overall advance of the stock index.

Some issuers of indexed annuities allow for a “death benefit” clause in the annuity contract. A death benefit will generally pay the estate of the decedent in the amount of all contributions made to that point, less any fees or withdrawals. Most issuers will require a certain number of years of participation before any death benefit kicks in.

Summary

Indexed annuities are a way to safely guarantee growth in a retirement account, while still participating in stock market advances. They have the advantage of being tax-deferred, with potentially higher rates of return than other annuity types. For someone planning for retirement and making regular contributions to an account, indexed annuities can be a wise choice. With many underlying indices to choose from and many options available, indexed annuities are well worth a look.

Pros and Cons of Variable Annuities

A variable annuity is a type of investment contract that is designed to provide tax-deferred income in retirement. Variable annuities can be purchased using either a lump-sum payment or through a series of payments, as into an IRA or retirement savings account. There are options within a variable annuity plan that allow the holder to allocate money into different investment types or sectors of the market. Variable annuities are usually sold through insurance companies, and can be considered a form of retirement insurance.

Variable annuities were introduced by a large teacher’s retirement fund in the early 1950s as a way to fund pension agreements. Prior to their introduction, inflation claimed a large portion of the teachers’ retirement savings because the benefits were made as fixed payments. Since variable annuities paid an amount that was based on market performance, the payments generally kept up with inflation. They gained in popularity among the general public in the 1970s and 1980s, largely due to high rates of inflation that were present during that time.

How Variable Annuities Work

As with other types of annuities, variable annuities have two phases, the accumulation phase and the payout phase. During accumulation, the annuity holder pays into the annuity account, and when a certain milestone is reached – usually retirement age – the payout phase begins. The “variable” in variable annuities, refers to the amount paid to the recipient during the payout phase. With a variable annuity, the amount paid to the holder is based upon the performance of investments made during the accumulation phase of the annuity. This is what keeps inflation from consuming retirement funds in this type of annuity contract.

The investments that are made in a variable annuity account are generally placed into mutual funds. The investments are divided into sub-accounts, with each sub-account holding one fund. The variety and selection of mutual funds that can be invested in is usually large. Depending upon the risk tolerance level of an individual investor, a variable annuity can be structured to range from very conservative bond funds to more risky and higher performing stock funds. Since stocks and mutual funds have been show to grow an average of 14% over time, this can lead to a substantial retirement nest egg.

Advantages of Variable Annuities

As with any investment type, there are advantages and disadvantages to variable annuities. A variable annuity may be the right investment choice for one investor, and inappropriate for another. To understand if this type of retirement investment is right for you, let’s take a look at some of the positive aspects of variable annuities.

We know that variable annuities allow investment in a variety of mutual funds and even ETF funds, through sub-accounts. The fund investments in any of these sub-accounts may be changed or reallocated at any time, usually with little or no cost. This allows the annuity holder substantial control over his market exposure, and the potential of higher investment returns.

Money invested in a variable annuity is tax-free until it is withdrawn. The IRS limits the amount that can be deposited into a 401(k) or IRS account. Since there are no limits to the amount of money that can be deposited in a variable annuity account, this can be a great way to defer taxes on money that is received as a windfall.

Variable annuities offer income for life. This can be a way for an investor to create a secure pension for himself in retirement. Flexible terms are also available for many variable annuities. There are short, medium and long-range terms that can be applied, which may allow an investor quicker access to capital if needed.

Many variable annuity plans offer a life insurance option that allows for a beneficiary to take ownership of the account in the event of the holder’s death. This is a way to avoid probate and even death or estate taxes, since the annuity tax treatment rules still apply.

Disadvantages of Variable Annuities

As mentioned, variable annuities are not the perfect retirement investment for everyone. Factors such as age, income level, tax bracket or other considerations should always be taken into account when planning for retirement. Here are some of the potential drawbacks to variable annuities.

Issuers of variable annuities typically charge higher fees than standard mutual fund management fees. Many variable annuities charge expenses and insurance fees on each sub-account in the annuity. Often, commissions are paid separate from the management fees, adding to the cost.

Early withdrawal and surrender fees are another cost of variable annuities to be aware of. If there is a chance that you may need to retrieve your money from a variable annuity account before the payout phase, this may not be the best retirement choice for you. Although surrender fees disappear, usually after 7 years, early withdrawal penalties apply until age 59 ½.

There is also a potential risk of capital loss with variable annuities. Although not common, the principal amount in a variable annuity can depreciate in value from year to year. While it is unlikely that the entire amount would be lost, an uneducated investor could severely damage his retirement account by making unwise fund selections.

Conclusion

Variable annuities are a highly flexible way to save for retirement and protect wealth for many investors. Having a guaranteed income during retirement is a very attractive option for some. Consider all of the pros and cons when deciding whether this investment choice is right for you.

Lifetime Annuities Explained

A lifetime annuity is an agreement between an individual and an insurance company that, for a lump sum payment, the individual will receive an income for life. They are also sometimes referred to as immediate or income annuities. How much is received and whether it fluctuates over time depends on how the annuity contract is structured; but by definition, the individual cannot outlive his money. Lifetime annuities can be a very attractive option for those with longevity in their genes. If a family has ancestors who have lived into their 90’s and beyond, this is a way to ensure financial needs will be met, no matter how long one lives.

Since individual retirees have a diverse set of needs, it stands to reason that the lifetime annuities available are diverse as well. There are many options and riders that can be added to a lifetime annuity contract, designed to give the most flexibility possible to an individual in retirement. Lifetime annuities can be very simple as well, involving a single lump sum payment and regularly scheduled disbursements for life. Let’s look at some of the different types of lifetime annuities and how they work.

Types of Lifetime Annuities

A fixed lifetime annuity is perhaps the simplest type to understand. In exchange for the initial deposit, fixed payments are made monthly to the recipient for life. For additional cost, a spouse can be added and the annuity would extend to that person’s life as well. The interest rate that a fixed lifetime annuity earns is related to when the annuity is purchased, and can therefore be highly dependent on the economic conditions at the time. Often, a fixed lifetime annuity is not the best choice available.

An indexed lifetime annuity uses an underlying equity index such as the S&P 500, DJIA or Russell 1000 to determine the amount paid to the annuity holder. An indexed annuity is more complex than a fixed annuity, and often places rate caps on the amount of interest an annuity can earn. On the other hand, there is usually a guaranteed minimum amount of interest paid into this type of lifetime annuity, regardless of whether the index was positive on the year or not.

An alternative to the fixed and indexed type of annuity is the variable lifetime annuity. Variable annuities use investment in mutual funds to grow the value of the annuity over time. An advantage to this type of lifetime annuity is that the capital within the account can be invested in riskier but higher interest earning funds, ultimately paying the annuity holder higher returns. Since the responsibility for investment decisions is on the investor and not the issuer, this is a riskier type of lifetime annuity. Over time however, variable lifetime annuities tend to perform better than the other types.

Options and Riders for Lifetime Annuities

Lifetime annuities can be tailored to meet the needs of most retirees, since insurance companies offer many options and extra provisions that may be added to standard lifetime annuities. One such option or rider that may be added to a lifetime annuity is the coverage of a spouse. In the case of a typical lifetime annuity, the benefits cease when the annuity holder dies. With what are called joint-and-survivor annuities, the benefits will transfer to the surviving spouse, for the remainder of that person’s life. Since this type of benefit has the potential of costing more, an issuer will charge more for this provision in the contract.

Another option for lifetime annuities is inflation protection. Since indexed lifetime annuities adjust with market fluctuations and economic conditions, inflation protection does not apply to this type of annuity. Inflation protection is typically used as a provision in fixed lifetime annuity contracts. In this situation, payments may be structured to increase by a certain percentage over time, or they may be tied to the Consume Price Index (CPI), and adjust with fluctuations in that metric.

Since lifetime annuities are intended for retirement-aged individuals, there will most likely be no early withdrawal fees levied by the IRS. However, there may be fees and surrender charges issued by the insurer if the money is withdrawn from the account before maturity. If an annuity will be kept in place for a long time, choose the longest duration maturity available. Usually, even with long maturity annuities, after 7 years there is no surrender charge applied. Surrender charges apply only to withdrawals of capital; disbursements to the annuity holder are not subject to surrender fees, and they begin as soon as qualifications are met.

Other Advantages of Lifetime Annuities

Perhaps the biggest draw for lifetime annuity investors is the security and stability that they provide. When an individual invests in a lifetime annuity, the company providing that annuity is contractually obligated to making payments for the life of the holder, regardless of how long that may be. For a retiree who hopes to live a long and financially secure life, this is quite a guarantee.

Since lifetime annuities are sold through most insurance companies, it is easy to compare different plans side by side. And since a large number of insurers have been providing benefits for many decades, the records for performance are easy to track. For stability, security, and ease of comparison and purchase, lifetime annuities are one of the best retirement plans around.

Annuities and Life Insurance

You have probably encountered both annuities and life insurance before. These are the two primary products the insurance companies sell to protect your life over the long term. The concepts of an annuity and a life insurance policy are exact opposites.

An annuity is intended to protect a person from outliving his retirement assets, The annuity protects you, and possibly your family, from your living too long. A life insurance policy protects your family from your dying too early. Both concepts are extremely important and useful in your overall financial plan at any point in time.

Many times both annuities and life insurance policies are marketed as investments by the insurance agents. In addition to all the guarantees, they can make a very good case for why you should view these products as investments. This is the subject I will address here.

To understand if annuities and life insurance are viable investment products, we need to first review the basic types of policies sold by most insurance companies.

Annuities

There are 3 types of annuities being sold by insurance companies today. Each of these will have various offshoots or sub-products, but the all products follow these 3 concepts.

The first concept is the fixed annuity. This is the product most people are familiar with. You contribute an amount into an insurance company, and are guaranteed to earn a certain interest rate and payments when you retire. If you put in money over time or all at once, and receive your payments later when you retire, you have a deferred fixed annuity. If you deposit a lump sum of money now and begin to receive payments immediately, you have an immediate fixed annuity.

The second concept is legally a form of fixed annuity, but is different enough that it is usually listed as a separate form of annuity. This is the equity indexed annuity. On the surface, this annuity looks like a regular fixed annuity and has similar guarantees. However, the interest rate credited each month is not fixed, but changes to match the performance of an investment index, such as a long term bonds or even a stocks. You still get a minimum interest rate credited but benefit from the potential gain in the investment index.

The third concept is the variable annuity. This annuity actually allows you, as the contract owner, to select the investments that will be purchased with your contributions. Most contracts offer a wide array of mutual funds that can be used for this purpose. The amount you eventually receive each month at retirement will be dependent on the performance of the investments you selected. Due to the investment component, variable annuities are governed by the security laws and regulatory agencies, as well as the insurance laws and state commissioners.

There are many versions of each of the above annuity concepts. Each comes with a more impressive name then the next. They are also marketed in a number of ways so that the potential buyer will think these are investments sent from heaven.

Life Insurance

Life insurance products have also developed over the years to give more investment flexibility to the policyholder. All the products come under several general concepts.

The first life insurance concept is term insurance. This type of insurance has no cash value component, only pure insurance. Therefore, it cannot be considered an investment product.

The second type of insurance is whole life insurance. This type pays the face amount on the policy if you die, but also builds up cash value while you are alive and paying premiums. The cash value can be withdrawn by you or used to buy an annuity later on should you have no further need to the insurance coverage. So, a whole life policy is an insurance concept which can also be viewed as an investment while you are alive.

The variable life policy is the third concept. Similar to the variable annuity, a variable life policy allows you to invest the cash value of the policy in various mutual funds. Your eventual cash value and the face amount of the policy both adjust to reflect the investment returns of the investments you select.

Marketing of Annuities and Life Insurance Policies as Investments

You will see many advertisements using annuities as investments. This is logical since a deferred annuity is a vehicle for accumulating money, whether it is a fixed annuity or variable annuity.

You will never see a commercial touting the investment benefits of a life insurance policy. Even though there is a cash value accumulation, life insurance is marketed for protection, not investment.

The sales approach of insurance agents is another matter. These people will devise various sales pitches to convince you that both an annuity and life insurance should be in your investment portfolio. These sales presentations can be quite compelling since they emphasize the benefits in a given situation.

If you see a projection chart showing how you can accumulate $1 million at retirement under either an annuity or life insurance, with a relatively cheap payment each month, you are going to listen and get interested. They never do a comparison with other investment products because this would then bring up the disadvantages of using an annuity or life insurance as an investment. Along with the investment projection, they then tout all the guarantees that you get under these contracts and policies.

Annuities as Investments

Would you consider investing in an annuity if you can invest in a 401k? You probably would not, but you should look at the advantages of an annuity. Most financial planners would advise against opening an annuity due to the high expenses involved in these contracts. However, there is one psychological point which most financial planners do not focus on. That point has to do with the lack of security in retirement if the 401k is your only form of retirement savings.

Retirees who might have $1 million or more in a 401k still report their being financial insecure. The reason is that they don’t know how long they will live, and therefore, don’t know how much they can withdraw each month. The financial planner can give them a lot of projections, but they cannot give them a feeling of security. The payments are not guaranteed for life.

Having an annuity at retirement gives the retiree a feeling of security. If he lives to 110, he will continue to receive a check each month. No other financial product can offer the security of an annuity. For this reason alone, you should consider adding an annuity as part of your overall retirement savings program. Of course, you need to read up on the advantages and disadvantages, and compare to other investments. Just don’t discount the security factor.

Life Insurance as an Investment

A good sales presentation on life insurance will include projections of the cash values after 20 or 30 years. The numbers can really be eye popping when you see the size of the value, which you can withdraw anytime you want. The problem with using life insurance as an investment are the costs and being at the mercy of the insurance company in how much you will earn on your money. You are paying for protection against dying early. On top of that, you pay for high annual expenses under the policy. If you do not need the insurance, these costs will make a life insurance policy the least favorable investment for retirement. You will realize this during the sales presentation, at which point, the sales agent will then tout the life insurance protection you get along with the investment.

You should never consider investing in life insurance policy unless you need the insurance protection for you and your family. Protection against dying early is the reason you buy a life insurance policy. Having a cash value in the policy is a secondary consideration.

Annuities and Life Insurance have their Place

An annuity should always be considered for long term security. You may decide against an annuity given the costs and your particular situation. However, you should not ignore the advantages of an annuity merely because you will be committing money long term to a rather inflexible investment. Picture yourself in retirement having the security of a monthly check coming in.

Life insurance definitely has its place in your financial plan. In fact, life insurance and other insurance coverage is one of the first areas a financial planner will review. Safety first is the general theme. You can and should consider your life insurance cash values when planning for retirement. When you no longer need the life insurance, such as the kids are grown and gone, these cash values can be used to provide a comfortable retirement. Again, if you do not need to buy life insurance protection, look elsewhere for a place to invest for retirement.

Benefits of Being an Annuity Owner

You have probably read articles before on the advantages and disadvantages of being an annuity owner. You can pick apart all of the contract provisions to find if they meet your overall financial objectives. Financial advisers will describe a 20, 30, or 40 year old considering the purchase of an annuity and project the amount he will have at retirement. They then proceed to zero in on expenses, flexibility, tax, and growth aspects, and compare the annuity to a stock market investment to see if you are getting a good deal. These articles will be supported by a lot of examples projecting the annuity results years into the future. After all of that, you will find that you are still left with an uncomfortable feeling no matter what you decide to do. The reason is that the articles and the financial advisers always compare putting all of your money in one investment or the other. They almost never talk in terms of an annuity as part of an overall, well diversified financial plan. It is curious that the articles and advisers will always end their analysis with a paragraph on how you need to diversify when considering any investment.

Here I am going to focus more on the psychological benefits of being an annuity owner which are either missing or downplayed so many times by the financial advisers. These benefits are general in nature and would apply if you had bought a fixed annuity, variable annuity, equity indexed annuity, or any other offshoot of these concepts.

Retirement Security and Peace of Mind

The original concept of an annuity was, and still is, for you to put money into a contract either periodically or as a lump sum, and then receive guaranteed payments in retirement. If you are in your 60’s or 80’s, and have an annuity, you already know the feeling you get from having an amount coming each month for as long as you live. You may wish it were more, but the psychological impact of having this certainty in retirement takes away that some of that daily feeling of financial insecurity that nags so many people these days.

If you are lucky enough to be working at a job where you are covered under a defined benefit pension plan, you know the concept and the feeling, even though it is your employer who is making the contribution in most cases. You work hard at your career, then retire and receive monthly payments for life. You may only receive 20% or 40% of you salary when you retire, but you know this amount will be paid month after month.

These days, most financial advisers lead their clients to more flexible savings programs with the assets being invested in the stock market. Also, companies are terminating the defined benefit pension plans and replacing them with either 401k or cash balance pension plans. Each of these trends allow for more potential growth of your assets during the accumulation phase and, therefore, a larger pot of money to live on in retirement. This can very well be true, but all psychological security has been eliminated.

The common retirement situation today is that a worker approaches retirement and has all his assets partly in a 401k, part in a cash balance retirement plan, part in an IRA, and hopefully, some outside savings. So, the new retiree looks at this pot of money and could be quite happy. He may have accumulated over $1 million and thinks retired life is going to be fabulous. Add in Social Security and he is set for life. But is he really mentally set for life?

Ask any new retiree with the above situation how he feels and he will tell you his primary concern is outliving his assets. He may have a nice pot of money, but he is scared to spend any of it. The financial adviser will guide him on how much he can withdraw each year, which will usually be in the neighborhood of 4% of assets. Yet the problem the adviser cannot help him with is determining how long will he live and need to withdraw the money. Nobody can help with this issue. Will you live to age 70, so can spend as much as you like? Or, will you live to age 105 and run out of money?  With this insecurity always present, the retiree is then scared to put any of the money in investments which can fall in value, such as stocks and bonds. This insecurity can be so intense that the retiree goes out to find a job just to relieve the mental pressure. This problem is creating a psychological neurosis in today’s retirees. This neurosis has always existed in retirees who never had a defined benefit pension plan. However, the number of retirees experiencing this mental problem these days is rapidly rising with the termination of defined benefit pension plans. It is rising so fast that articles are now being written describing the mental problem. Professional therapists are seeing a dramatic increase in the psychological effects of financial insecurity in retirees. Of course, there are other factors that produce financial insecurity, but the lack of lifetime guarantees without a job to produce current salary can be psychologically devastating.

Being an annuity owner can relieve some of the financial insecurity at retirement. This is especially true if the annuity is part of a larger overall financial plan. If a working person knows that he will have some guaranteed income at retirement, be it in a pension plan or an annuity contract, he can then focus during his career on other savings programs.

Annuity as Part of a Diversified Financial Plan

If you have a defined benefit pension plan, you are probably concentrating on putting your money in a 401k, IRA, or simply putting money in a savings account. This is appropriate and will provide the needed flexibility in retirement. You will have a monthly check coming in from the pension and will have a pot of money to supplement that.

If you do not have a pension plan, and have all your money accumulating in a 401k or IRA’s, consider starting a deferred annuity program. A deferred annuity will not give you a tax deduction when you put in the contributions, but it will grow tax free. More importantly, a portion of your overall assets at retirement will be in the form of monthly guaranteed payments which will relieve some of the insecurity issue described above.

Many advisers will tell you to accumulate all assets in a 401k or IRA during your career, and if desired, take a portion of the assets and buy an immediate annuity contract when you retire. This is a good strategy which will give you more flexibility prior to retirement and then the desired security during retirement. The problem is trying to convince a retiree to part with 30% – 40% of his money to purchase an annuity. Many retirees simply won’t take this advice. They feel this suggestion takes away all control over their money when it is time to make a decision.

If you worked for 30 years and retired with a monthly annuity or pension, and also had a pot of money in a 401k, you will be quite happy. On the other hand, if you had a much larger 401k balance, but no monthly pension at retirement, you could take a portion of the 401k balance to buy an annuity at retirement and be the same or better financial position as the first situation. Psychologically, you are not in the same position. Asking you to give up 40% of you 401k balance to buy an annuity is a very difficult discussion. You will come up with every reason why you do not want to do it. So, I am suggesting that you consider buying a deferred annuity contract during your career so you do not have to decide at retirement. I understand that you may lose some growth potential during the working years, and you may lose some tax benefits. I am making the suggestion to prevent some of the psychological issues at retirement.

Mental Security Is a Priority

As you can imagine, I could argue that there are much better financial methods to produce greater assets at retirement, which in turn produce more financial security in retirement. If the mental retirement issues did not exist, I would suggest you accumulate most of your retirement assets in a well diversified set of mutual funds while maxing out your contributions to a 401k and IRA’s. However, the mental or psychological effects of not having a guaranteed monthly pension definitely exist at retirement. Not enough attention is paid to these issues by financial planning professionals.  If you are currently working, you may have a hard time picturing these problems because you have a salary coming in. If you have been laid off during your career, you have experienced financial insecurity. Now try to picture yourself as a retiree with that daily feeling of insecurity even though you might have a large amount of money sitting in a 401k account. Retirement is the time in your life when you want to feel secure. Having an annuity at retirement will relieve some of the pressure.  Survey some retirees to see if this is true. I think you may give annuities a closer look when you hear their answers.

 

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