What a time to be alive! Advances in health care, medicine, and technology are adding years to the average life expectancy of many Americans. About one out of every four 65-year-olds today will live past age 90, and one out of 10 will live past age 95, according to the Social Security Administration.
As life expectancies lengthen, the challenge of planning a well-funded retirement that includes income also increases. Annuities are one retirement planning vehicle that can offer an income stream to help cover living costs in your golden years. Here, we’ll dive in to one specific type, the deferred-income annuity.
"Clients who have a fear of outliving their money may greatly benefit from purchasing an annuity," says Kelly Paiz, senior annuity consultant at TD Ameritrade. "Those who invest more conservatively or have concerns of outliving their money will find that annuity contracts can help provide a consistent income stream.”
An annuity is a contract between an insurance company and an individual or couple, and generally falls into two main categories: growth or income. Growth annuities are issued with a fixed or variable rate of return. Income annuities may include a growth component, but their main goal is to create a guaranteed stream of income that cannot be outlived.
There is another type of annuity — the deferred income annuity — that combines the characteristics of both the growth and income vehicles into one product. An individual who purchases a deferred income annuity will receive a steady stream of income starting at some point in the future that will continue for the rest of his or her life.
But there’s more to it: the longer you delay the payment, the more the income payment grows. “Using these products to cover essential expenses in retirement may be one of the best ways to use a small amount of assets for a larger stream of income," Paiz says.
The rising cost of health-care and medical expenses in retirement are an unknown. Annuities can be used in conjunction with current individual retirement accounts (IRAs) to help provide for financial needs in retirement, including health-care expenses. Some annuities offer the option to defer a portion of one's IRA accounts as far out as age 85.
"Using this strategy with a portion of your IRA or non-IRA money can help you to self-insure long-term care or health-care costs down the road. Deferring some of your IRA assets for these costs have helped individuals to better prepare for rising health-care [costs] while still maintaining control of how those income payments are spent or what they can be used for, such as in-home care or a qualified nursing facility," Paiz says.
As with every investment, it pays to do your homework and to understand all the terms. With an annuity, as with all insurance products, individuals are essentially paying for protection. Fees and costs can have a potentially negative draw on overall portfolio performance. Also, it’s important to ask the annuity provider about surrender periods, when investors have to lock up money for a certain period of time — for example, once they have started to receive income.
Higher-tax-bracket investors who are looking for growth and have already maxed out their IRA and workplace plan contributions can potentially benefit from additional tax deferral with annuities.
There are other advantages to adding an annuity to a broader retirement plan. For example, annuities tend to be more flexible: They don’t have income limits, contribution limits, and some do not require that you start taking distributions at a certain age.
Higher-tax bracket investors who are looking for growth and have already maxed out their IRA and workplace plan contributions can potentially benefit from additional tax deferral with annuities. See your tax professional for more assistance.
The prospect of living long can be a little scary, especially when we start to think about living comfortably. Consider annuities as one approach that can help you make sure you don’t outlive your income.
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