3 Wrong Reasons For Saying No To An Annuity…And 3 That Make Perfect Sense
Even the best annuities—i.e., relatively uncomplicated ones that generate lifetime income without expensive bells and whistles—aren’t for everyone. But if you’re going to exclude an annuity from your retirement income plan, be sure you’re doing so for a valid reason. With that in mind, here are three flawed rationales for nixing an annuity and three totally legitimate reasons for giving an annuity a pass.
3 Faulty Reasons For Rejecting An Annuity…
1. Annuities stir up unpleasant thoughts of our own mortality. If you haven’t heard of the term “mortality salience”—an awareness of the inevitability of one’s death—not to worry. I hadn’t either until I came across a recent research report titled “Solving the annuity puzzle: The role of mortality salience in retirement savings decumulation decisions.” Essentially, the study confirms that many people don’t want to even think about buying an annuity because doing so forces them “to consider their own death.”
Granted, dwelling on your eventual demise isn’t exactly a prescription for enjoying retirement. On the other hand, if you want to come up with a reasonable plan for spending down your nest egg, you’ve got to recognize that your time in this earth is finite. No one gets out of here alive. So don’t worry so much about how much time you have left. Rather, consider whether an annuity might make for a happier retirement by helping you get the most out of your savings while you’re still here.
2. You fear you’ll have “wasted” your money if you die before collecting many payments. There is a kernel of truth to this line of thought. If you have a health condition that you’re certain will dramatically shorten your lifespan, then turning over savings to an insurer for the promise of lifetime payments probably doesn’t make much sense (although you should also consider the life expectancy of your spouse or significant other, if you have one). But if you’re a relatively healthy 65-year-old, for example, recent life expectancy stats suggest that you are likely to live another 20 years or so, if not much longer.
That doesn’t eliminate the possibility that you could be one of the people who fall at the short end of the life expectancy continuum—or, to put it more bluntly, that you may die sooner rather than later. But even if that turns out to be the case, it doesn’t mean you “wasted” the money you put into an annuity any more than people who paid homeowner’s insurance premiums for years blew that money because their house didn’t burn down. At heart, an annuity is a form of insurance that helps you get more spending income from your savings while you’re alive while also guaranteeing that you’ll still have money coming in even if you stay alive a long, long, long time.
3. You won’t be able to tap the savings you devote to an annuity. To get highest monthly payment from an immediate annuity or a longevity annuity, you give up access to the funds you invest in the annuity. So, yes, in return for guaranteed lifetime payments, you no longer have the ability to tap into that money for emergencies or unexpected expenses or to leave it for your heirs.
But that’s why you almost certainly shouldn’t put all, or even most, of your nest egg into an annuity. Instead, by funding an annuity with only a portion of your savings and investing the rest in a diversified portfolio of stock and bond mutual funds for growth potential, you can reap the advantages of an annuity (income you won’t outlive no matter what’s going on in the financial markets) while still having the remainder of your nest egg invested so it remains accessible yet can grow over the long term.
…And 3 Valid Reasons For Saying No
1. You already have enough assured income. When deciding whether to buy annuity with a portion of your nest egg, you should really be asking yourself whether you need another annuity, because you already (or will at some point) have one in the form of Social Security. And you could even have a second annuity if you qualify for a pension and take it as monthly payments rather than a lump sum.
So the real issue is whether you need more guaranteed income than you’re already getting or will receive. If your Social Security benefit (or projected benefit, which you can determine by going to Social Security’s Retirement Estimator tool) and pension payments, if any, are enough to cover all or most of your essential retirement expenses (which you can estimate by using BlackRock’s Retirement Expense Worksheet or the budget worksheet in Fidelity’s Retirement Income Planner tool), then you may not need more guaranteed income from an annuity. You may be better off investing your savings in a well-balanced portfolio of stock and bonds and withdrawing money as needed to cover discretionary expenses and any other costs that pop up.
2. You have a very large nest egg. If you think of an annuity as insurance against running through your money too soon, then you don’t need that insurance if your nest egg is so big that your chances of depleting it in your lifetime are slim to none. Warren Buffett will get along fine without an annuity. Ditto for Bill Gates.
But even if your wealth isn’t anywhere near Buffett or Gates territory, your odds of outliving your nest egg may still be extremely low if the amount you withdraw each year to pay expenses not already covered by Social Security and any pensions amounts to only a very small percentage of your savings and other retirement resources (home equity, cash value life insurance, etc.). To gauge whether your estimated withdrawals are likely to put you at risk of running out of money during your lifetime, you can check out this retirement income calculator.
3. You’re just not sure an annuity’s right for you. Extricating yourself from an annuity can be a lot more complicated and expensive than, say, switching from one mutual fund to another. So you shouldn’t buy an annuity unless you’re truly convinced that doing so is the right move.
In fact, even if you’re reasonably confident that an annuity can play a role in your retirement income plan, you may still want to hold off a bit before buying. The reason: Delaying until after you’ve lived a few years in retirement can give you a better chance to see how much you’ll actually spend and thus better assess how much, if any guaranteed income, you need beyond what Social Security and any pensions will generate. And even if you decide to go ahead, you may want to “annuitize” gradually, spreading your money among annuities from a few different highly rated insurers over a period of several years, to avoid the risk of investing all your dough when interest rates and annuity payments are at or near a low.
But given the fact that getting out of an annuity can be a lot more difficult than getting into one, committing to an annuity isn’t something you should do as long as you have lingering doubts. (5/11/16)
Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at email@example.com. You can tweet Walter at @RealDealRetire.
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