While retirees often worry about making their money last, many don’t take advantage of an insurance product that helps them do just that.
A new study shows how income annuities can help bridge the financial uncertainty gap in retirement by providing consumers with guaranteed income in the form of monthly "paychecks." Specifically, researchers found that adding an income annuity boosted the chances of a retiree's portfolio lasting until age 95 by around 20 percentage points, versus a portfolio with investments alone. The study was funded by Principal, a financial management and insurance company, and conducted by Michael Finke and Wade Pfau, two researchers with The American College of Financial Services
To be sure, as a company that sells annuities, Principal has a vested interest in promoting them. Still, some academics agree that the simplest types of annuities are worth a look.
“Annuities assure you that you’re not going to run out of money," says Alicia Munnell, director of the Center for Retirement Research at Boston College.
Although annuities have failed in the past to gain much traction with older Americans, they are growing in popularity as life expectancy increases and health care costs continue to rise. Last year fixed annuities saw $133.5 billion in sales, an all-time high, according to the Life Insurance and Market Research Association.
To buy an income annuity, you simply give a portion of your retirement savings to an insurance company, which then guarantees you a monthly check for as long as you live--or, for a fixed period of time, if you choose a term annuity. Yes, you sacrifice liquidity and any gains that money would have make in the stock market, but receiving a monthly paycheck just like you did during your working years can provide peace of mind for many people, especially since a growing number of Americans will now have to make their retirement savings last for three or four decades.
In an example from the study, owning an income annuity improved the probability of people's money lasting until age 95. For a 55-year-old couple who plans to retire in 10 years, purchasing a $100,000 deferred annuity whose payments begin at age 65 would give them an annual income of $7,780, whereas an investments-only approach with a portfolio of 60% equities would give them just $4,060 in sustainable annual spending. If they took a combined approach (devoting half of their portfolio to an annuity and putting 80% of the remaining assets in stocks), they would have a 77% probability of making it to 95 without outliving their money, compared to a 60% success rate relying on an investments-only allocation with 40% in stocks.
Not all annuities are created equal, however. Thanks to their simple guarantee, the income annuities studied in the report may be worth considering for the average investor. But other, more complex options, like variable annuities and indexed annuities, are something to think twice about. These products layer investments on top of an insurance contract, and they are much more expensive than simply investing on your own in a low-cost index mutual or exchange-traded fund. (It's hard to tell exactly how much variable annuities cost, though, since their fees are generally baked into the product and silently eat into your returns.)
While annuities offer more guarantees than investing directly in the market--for example, some complex annuities set a floor under how low your returns can go, regardless of how stocks perform -- many fiduciary advisors say the cost isn't worth it.
As for guaranteed-income annuities, consumers historically haven’t embraced these simpler products despite the consistent cash flow they can provide. Concerns about losing liquidity are one reason why. In the most basic product, known in the industry as "life only," your heirs don't get any money back when you die. But there are products that do offer some money back to your heirs in return for a lower monthly payout when you're alive.
Indeed, annuities' liquidity fears have a flip side: while buying a deferred income annuity may tie up some of your cash before retirement -- you can get some of the best rates in your 50s -- the purchase frees up some of your money after retirement.
"People are scared to death of late-life health costs," Munnell says, and often deprive themselves of things they really need in order to keep as much money as possible squirreled away for a rainy day. "If you have an annuity check, it says to you, you are enabled to spend this much money on yourself. So it gives people a license to spend some of their balances which they would otherwise be reluctant to do."