Should you annuitize your retirement income?
Should folks in or nearing retirement buy an annuity? If so, what’s the best time to pull the trigger on that purchase?
Generally, I’m not a big fan of annuities, especially when interest rates are low as they are now. There are usually better ways to provide a retirement income. Annuities are risk-free but risk-free comes at a price.
What is an annuity?
An annuity is a product purchased from an insurance company. You pay a lump sum and the insurer promises to pay you an income for life. Because the income never stops, you can do well if you live a very long time. However, rates are determined by prevailing interest rates so they pay better if purchased when rates are high.
An annuity can be useful for creating a secure source of retirement income. You lose some upside potential but an annuity allows you to eliminate major investment risks and it provides income that you cannot outlive – no matter how long you live. Risk-averse people really like that and don’t mind missing on those large gains in order to protect on the downside.
Related Article: Using Annuities to Guarantee Retirement Income
When is it best to annuitize?
Fred Vettese, in his book The Essential Retirement Guide: A Contrarian’s Perspective, writes that retirees must decide how much of an annuity should be converted – all of your savings, or maybe just some or none.
There are a few situations when annuitizing might not be your best option. A traditional investment portfolio is better for maximizing your estate for your beneficiaries, although an annuity can also provide estate value if it’s properly structured. An annuity may not be your best choice if your life expectancy is short (perhaps due to family factors). If you’re comfortable investing or if you have an advisor then you’ll probably better off with an investment portfolio.
It can make sense to move the fixed-income portion of your investments such as GICs (guaranteed investment certificates) into an annuity. Vettese says that you should convert at least $100,000 for it to be worthwhile. You might consider using annuitizing for the income you need to provide your basic expenses and investing the rest of your money for growth and flexibility.
One often overlooked benefit of annuitizing that Vettese discusses is that it takes money out of your hands, eliminating the risk of spending your savings too quickly or of making bad investments. Think of this as insurance against bad decisions.
Related Article: Is an Annuity Right for You?
Rarely should you use an annuity for all of your savings. This eliminates the flexibility to make large expenditures or to give cash gifts to children, for example.
It’s helpful to understand how insurance companies value annuities. Insurers will sometimes price them more aggressively – sort of like a sale for annuities. This can occur when companies haven’t done as much annuity business as they require or when an insurer has access to favorable private fixed-income money, savings that can be passed along to the consumer.
However, don’t try to time the annuity market. Make decisions based on your need for guaranteed income and prevailing interest rates and don’t think too much about the other factors that could affect prices months down the road.
Talk to your financial advisor to determine if you’re a good candidate for an annuity or if one of the other products might be more appropriate for your needs.