Retirement income planning is not what it used to be. The good news: people are living longer and enjoying healthier, more active lives and pursuing new passions in retirement.
Yet longevity poses challenges for how clients will manage their retirement savings. In fact, according to a recent survey conducted by RBC Wealth Management, running out of money is the top concern of today’s retirees and those approaching retirement. Knowing that they can’t solely rely on pensions and Social Security to cover everyday expenses, creating reliable income in retirement—a “retirement paycheck”—is vital to their long-term security and confidence.
That need for regular retirement income is driving an increased interest in annuities, says Troy Randall, senior manager of Insured Solutions at RBC Wealth Management–U.S.
“People are learning that annuities offer tax advantages as well as income,” Randall says. “In many situations, annuities can be a crucial component of a complete wealth plan.”
Here’s what you need to know about annuities and how they can help you meet your retirement planning goals.
What are annuities?
Annuities are income investments for retirement offering a guaranteed monthly payment stream in exchange for that investment. Compared to stock market investments, which can provide income but also fluctuate in value based on market movements, annuities offer a guaranteed source of income that does not change as a result of the market, explains Mike Clark, an annuity and life insurance consultant at RBC Wealth Management–U.S.
The amount of income you can expect from an annuity varies based on the amount you invest and the type of annuity you select. Generally, most annuities pay 4.5 percent to 5.5 percent annually, Clark says. For example, if you were to invest $1 million in an annuity, you would get approximately $50,000 annually for the rest of your life.
“Having that income you can count on gives you something on which to base your budget,” Clark says. “Even if the asset went to zero, the insurance company has to continue paying you—and your spouse—if you include them on the income guarantee.”
What benefits can annuities offer?
By providing a guaranteed income, one of the biggest benefits of annuities is that they can help provide a reliable paycheck in retirement. With Americans now living longer than ever, the possibility that they will outlive their retirement savings is increasing. Annuities provide stability and reliability that can help people plan for this longevity risk.
But guaranteed income isn’t the only benefit annuities offer. Because annuity investments grow tax-deferred until the funds are withdrawn, they can help you accelerate your retirement savings. For example, if you cashed out a traditional IRA and rolled it into a qualified annuity, you wouldn’t pay any taxes on the growth until you begin taking withdrawals. When you’re no longer working and may be in a lower tax bracket, your annuity withdrawals could be taxed at a lower rate, Clark explains.
Additionally, annuities can also help diversify your retirement portfolio and protect your principal. “People want to protect what they’ve accumulated rather than risk losing it if the market corrects,” Clark says. “With an annuity, you can put a floor on some of those investments.”
Certain types of annuities allow investors to participate in the market and enjoy market gains while protecting their principal investment, Clark explains.
And because there are different options available, most investors will be able to find an annuity that meets their risk tolerance and suits their specific needs, Randall says.
In that way, he adds, they’re a lot like apples.
“There are Granny Smith and Red Delicious and Honeycrisp apples—they’re all slightly different, but they’re all apples,” he says. “With annuities, there are varieties designed to meet different needs. For conservative investors there are fixed rates; for others there are variable rates; and there are also indexed annuities tracked to market indexes, so you can be in the market and get the upside along with principal preservation.”
Should you invest in annuities?
Despite the many benefits offered by annuities, they may not be right for everyone or every situation. For instance, people who are young and won’t retire for a while have plenty of time to invest in the market and grow their money, Clark says. Purchasing an annuity at a younger age may be premature, as you would be paying an additional expense that is not necessarily providing value when your retirement is in the distant future.
Likewise, as you approach normal life expectancy, the value of annuities may begin to diminish, Clark says.
“The sweet spot for benefiting from the guaranteed income provided by an annuity is to start the investment between your late 50s and mid-70s,” he says.
Similarly, if your goal is to leave a legacy for your family rather than create retirement income, annuities may not be the right strategy. Annuities can be passed to heirs, but because there can be tax implications for inherited annuities, they are not the most efficient products for that purpose, Randall says.
But if you’re working to fully fund your retirement and are looking for options to create retirement income, protect your investments, diversify your portfolio and manage taxation, annuities may be a viable option for meeting your goals.
Like any investment, an annuity should be incorporated into a comprehensive retirement plan, and “should never dominate a portfolio,” Randall says. But as a part of your overall plan, annuities can play an important role in helping you accomplish your financial goals and plan for a secure retirement.