Americans today are living longer than previous generations. That’s the good news. The challenge is coming in saving for retirement and ensuring those savings last a lifetime.
Meeting the challenges of retirement savings has always been a difficult prospect, but in today’s volatile economic environment and a reduction in the income provided by employer-sponsored pensions, the challenges are steep and require more knowledge and initiative.
In most cases, pensions have been replaced by defined contribution plans, such as 401(k)s and individual retirement accounts (IRAs). This means that employees and investors must bear most of the responsibility for building their own retirement portfolios. Because of the nature of 401ks and IRAs, these savings are much more exposed to the whims of global financial markets, leaving savers with more uncertainty.
Increasingly, financial advisors are recommending annuities to help alleviate retirement savings uncertainties and replace the guaranteed income that a pension would supply.
Different Types of Annuities
There are different ways to invest in annuities based on the purchaser’s needs. Investors can purchase a fixed annuity in which the payments are spelled out exactly ahead of time in the contract. Alternatively, investors can purchase a variable annuity that will invest funds in the market. While there is more potential for growth with a variable annuity, there is also more risk since it’s essentially based on an investment portfolio and subject to market whims.
Before you choose an annuity, it’s a good idea to consult with a financial investment management advisor to determine what type and configuration are right for you. Regardless of which type of annuity you choose, the power of tax deferral means you can build up your retirement savings more quickly, leaving you with more money to do work for you.
What Are the Benefits of Annuities?
With an annuity contract, investors are essentially buying a stream of payments that will be made to them over time to protect against the risk of outliving their income. There are many different annuity types, allowing investors to find one that ideally fits their lifestyle and retirement plans. There are benefits available that guarantee income, as well as locking in death benefits for loved ones.
Because annuities are tax-deferred, annuity holders don’t pay taxes until they withdraw their money. Deferred annuities take advantage of this deferred tax paradigm by putting off tax payments until retirees begin receiving income distributions. The growth that happens in the tax-free interim can significantly build a retirement portfolio.
As an example of how this tax-deferred process can work, consider the purchase of a $100,000 annuity compounded at a five percent annual rate for 20 years. Tax-free, this money would grow to $265,330. If the investor withdrew that money in a lump sum and paid a 32 percent tax rate on it, they would come out with $212,424. However, if the saver put the $100,000 into a taxable investment account, they would realize only $149,765 in that time.
What Are the Drawbacks of Annuities?
After going through the Rolodex of great benefits annuities may offer, many people find themselves asking the age-old question: what’s the catch? Any time you see guarantees with an insurance-related product, there is almost always a caveat or trade-off that needs to be considered in the decision-making process.
Limited investment options are a theme in many index and variable annuities. Are there any contracts with more investment flexibility than others? Absolutely. But every annuity limits contract holders to a list of funds/crediting strategies, and in some cases, dictates account allocations and caps returns on a particular index. This can often result in muted returns that the investor would not otherwise be subject to in a taxable brokerage account.
Many annuities come with a base M&E (mortality risk and expense) charge, sometimes coupled with living and/or death benefits — guaranteeing payments during life, or locking in death benefits for heirs – that almost always come with additional expense. In fact, it would not be abnormal to see some annuity contracts costing over 3% in annual fees. While some investors are happy to pay such an expense for security and peace of mind, others may opt to forgo the insurance benefit because they believe they emulate the same benefits in the market without the expense.
Is An Annuity Right for Me?
Although all portfolios should be tailored on a case-by-case basis, annuities should be recommended with elevated care. Not only are annuities often expensive, but it is not uncommon for contracts to come with multi-year surrender charges that may prevent contract holders from accessing their money without penalty. These are some of the reasons that annuities have gained a less-than-stellar reputation. With that said, when an investor has been made aware of the pros, cons, and mechanics of an annuity, it can play an invaluable role in the confidence of their retirement income plan.
Consult a Financial Advisor
At Toomey Investment Management, Inc. (TIMI), our business model is designed to treat all our clients equally and fairly. We realized long ago that the financial industry dedicated many resources to capturing money from prospective clients but much less to service and accountability for existing clients. At Wallingford, Connecticut-based TIMI, we listen carefully, keep in touch, and return your calls and communications quickly, so you can count on us. We will work effectively to optimize your retirement savings options and solve your problems. Call us at 203-949-1710 or visit our website for more information.