Thanks to advancements in healthcare, nutrition, and technology, people are living longer than ever before. As per the CDC, the average life expectancy in the United States is 77.5 years. For males, this equates to 74.8 years; for females, it equates to 80.2 years.
Even though this is a cause for celebration, it poses a unique challenge: how do you make your savings last longer? Both the middle class and the wealthy share this concern.
In a Transamerica Institute report, 21 percent of 10,000 respondents earning $50,000 to $199,999 a year said they were “not very confident” of retiring one day. Furthermore, according to the Wall Street Journal, even wealthy retirees worry about outliving their money.
However, you can protect your nest egg with annuities, which offer a steady income stream. Even so, understanding how annuities work and their benefits can help you make better financial choices if you’re still concerned about outliving your savings.
What Are Annuities?
Before going any further, let’s quickly recap what annuities are.
An annuity is a contract between you and an insurance company. As part of the agreement, the insurer agrees to provide regular income payments immediately or in the future. Several types of annuities are tailored to different financial goals and risk tolerances.
- Fixed annuities. With guaranteed income payments at a fixed rate, these are a low-risk option for retirees seeking stability.
- Variable annuities. These allow investors to choose funds, varying their income according to the performance of their investments.
- Indexed annuities. With these, you can earn higher returns while protecting yourself against market downturns.
- Immediate annuities. You begin receiving payments almost immediately after making a lump-sum payment.
- Deferred annuities. Over time, you can accumulate savings and receive income payments later.
Why Consider Annuities?
Unlike stocks or mutual funds, annuities offer predictability and security that other retirement income options don’t. In contrast to investments in the stock market, annuities can guarantee a consistent income regardless of market conditions.
In addition, annuities can bridge the gap between Social Security benefits, which may not be sufficient to cover all retirement expenses, by providing a reliable and supplemental income stream.
In any case, let’s take a closer look at why you should consider annuities;
Longevity risk.
One main reason retirees consider annuities is to address “longevity risk.” After all, it’s always possible for someone to live longer than expected when they retire. If they withdraw money at a fixed rate, they could potentially deplete their retirement savings.
How do annuities address longevity risk? When retirees purchase an annuity, they exchange a lump sum for a lifetime of guaranteed income payments. They’ll still have a steady income even if they live longer than expected.
Predictable income.
In contrast to other investment options, annuities provide a predictable income stream regardless of market conditions. During economic downturns, when other sources of income may be affected, this stability is particularly valuable.
The most straightforward annuity is a fixed annuity, which provides a predictable and reliable income. With a fixed annuity, you receive a steady income stream from your insurance company throughout your life or for a specific time period.
Tax advantages.
There are several tax advantages associated with annuities, including;
- Tax deferral. As long as you don’t withdraw money, you don’t have to pay taxes on your earnings. As a result, your money can grow tax-free and compound, increasing the growth of your investment.
- Lower tax bracket. If you begin taking withdrawals, you may pay less in taxes if you are in a lower tax bracket in retirement.
- Tax-free passing. When you name your spouse as a beneficiary, they won’t be taxed on the annuity when you die.
- Flexibility. If you withdraw money before you turn 59 ½, you may face a 10% IRS penalty as well as income tax.
Customizable options.
Your annuity can be customized in several ways based on your needs;
- Riders. Features such as long-term care or lifetime income benefits can be added at an additional cost.
- Contract negotiation. Talk about enhanced benefits for spouses and beneficiaries, as well as easy access to your money — depending on the annuity type.
- Penalty avoidance. You can alter withdrawals or receive a lump sum to avoid early withdrawal fees for deferred annuities.
- Portfolio index selection. If you choose a Fixed Index Annuity, you can select a market index that matches your risk tolerance. Based on the performance of the index, you will be able to calculate your potential return.
You can create an annuity that meets your financial needs and risk tolerance level using these features.
How Annuities Protect Your Nest Egg
As discussed above, an annuity can provide you with a steady income during your retirement years. As a result, you will be able to maintain a comfortable standard of living. However, annuities can also protect your nest egg in other ways.
- Guaranteed lifetime income. Among the most attractive features of annuities is the promise of lifetime income. So even if you live into your 90s and beyond, you won’t run out of money. With this assurance, you can enjoy retirement without constant financial worries.
- Hedge against inflation. With some annuities, you can protect your income against inflation, ensuring your income stays level over time. Over time, this will help you maintain your purchasing power.
- Market downturn protection. You can protect your principal against market volatility with certain types of annuities, such as fixed and indexed annuities. This can be particularly beneficial when other investments may lose value due to economic uncertainty.
- Legacy planning. If any remaining funds are in your annuity when you die, you can pass them on to your heirs by utilizing the death benefit option. As a result, your hard-earned savings will continue to benefit your loved ones, regardless of your death.
Are Annuities Right for You?
Despite their numerous benefits, annuities aren’t a one-size-fits-all solution. To help you make your decision, consider the following;
- Your financial goals. When planning for retirement, annuities can be a valuable addition. If you’re looking for high-growth investments, other options might be better.
- Your risk tolerance. While fixed annuities are an excellent option for those who prefer low risk, variable and indexed annuities are more suitable for those comfortable with some risk level in exchange for potentially higher returns.
- Fees and costs. Fees often accompany annuities, including administrative, surrender, and investment management charges. You need to understand these costs and how they impact your bottom line.
- Liquidity needs. Annuities may not be the best option if you need your funds immediately. Annuities are designed for long-term financial planning. Annuities usually have surrender periods during which withdrawals are punishable.
How to Get Started With Annuities
If you’re considering investing in annuities, make sure you do your research and understand the risks. Moreover, consult a qualified financial advisor to determine if annuities are right for you.
- Assess your retirement needs. Evaluate your current savings, expected expenses, and other income sources. In this way, you can determine how much additional income you will require when you retire.
- Research different annuities. Know the differences between the different types of annuities and the features they offer. If you need assistance navigating the complexities and finding the best fit for your needs, consider consulting a financial advisor.
- Compare providers. Check out different insurance companies’ offerings, paying particular attention to fees, payout rates, and financial strength ratings.
- Read the fine print. You should carefully review the terms and conditions of any annuity before committing. It’s important to understand the fees, payout structure, and withdrawal restrictions.
Conclusion
With life expectancy rising, financial security has never been more critical. In addition to offering guaranteed income, annuities protect your nest egg against market volatility and inflation risks. Even though they’re not suited to everyone, they can provide retirees stability and peace of mind.
When you understand how annuities work and evaluate your financial needs, you can make informed decisions to ensure your savings last a lifetime and beyond.
FAQs
How can an annuity help if I live longer than expected?
In certain types of annuities, there is a possibility of receiving guaranteed income for life. In other words, even if you outlive your life expectancy, you will continue receiving payments, providing financial security and peace of mind.
What is a longevity annuity?
Longevity annuities, usually called deferred income annuities, are designed to help retirees avoid outliving their savings. Typically, payments begin in your 80s or 90s. In comparison with immediate annuities, deferred payments tend to be higher.
How does my life expectancy affect the annuity payout?
The longer your life expectancy is, the lower your monthly payments from an immediate annuity will be. In this case, the insurance company expects to receive payments for a more extended period of time. On the other hand, a longevity annuity could be more valuable if you have a longer life expectancy.
Are there any special considerations for those with health issues?
In the event of a health issue that could shorten your life expectancy, you might find that an immediate annuity offers higher payments since it anticipates a shorter payout period. You must, however, weigh this against the potential need for greater access to your funds for medical expenses.
What happens to my annuity if I die before receiving all the payments?
Several annuities offer death benefits that can be paid to your beneficiaries.
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