For the 80 million Baby Boomers who are just now beginning to cross the retirement threshold, at a rate of 10,000 per day for the next 20 years, the concept of retirement planning has taken on a whole new meaning. Under the “new normal” retirement planning includes delaying the retirement date, planning for work after retirement, or lowering standard-of-living expectations. Retirement savers have had to endure two steep market declines (2000 and 2008), essentially flat returns during the decade of 2000, and, now a stymied economy that has shattered their confidence. No longer can anyone simply rely on the simple strategy of socking a part of their paycheck into a 401(k) and let it ride. Today’s retirement portfolio needs to be constructed in way that addresses all of the risks while keeping the door open for growth.
Annuities as a retirement savings vehicle have had their critics. Often labeled as too inflexible, or too expensive, or too illiquid, annuities have emerged as a critical component of a larger, more balanced retirement portfolio. When considered on their own, one might be able to make an argument as to their inflexibility or their expenses as being unsuitable for many investors. However, when considered in the context of a complete portfolio, they make much more sense than some of the alternatives. Let’s explore the features of annuity in the context of a retirement portfolio:
Tax Deferred Growth
When saving for retirement, or any long term objective, minimizing taxes on earnings is essential in order to maximize growth. The tax deferral component of annuities makes them attractive for anyone in the higher tax brackets who can benefit from minimizing taxes. As with qualified plans, taxes are paid on the earnings as they are withdrawn, and there are penalties for withdrawals made prior to age 59 ½. As part of a retirement portfolio, annuities should be considered when allowable contributions to qualified plans, such as 401(k)s, have been maximized as they do provide current tax savings that annuity contributions don’t.
Safety of Principal
Fixed annuities are considered to among the safest of all investment vehicles. With the principal backed by the assets of life insurance companies, the most stable of financial institutions, investors have the peace-of-mind assurance that a portion of their retirement portfolio will be secure no matter the economic or market conditions. A properly balanced portfolio should always have a portion of assets allocated to investments that are free of market risk. The amount of the allocation will depend largely on the risk tolerance and the growth objectives of the individual investor.
No Required Minimum Withdrawals
One of the problems with relying solely on a qualified plan for a retirement portfolio is that they require a minimum level of withdrawals to be taken at the age of 70 ½. With annuities, there is no such requirement, so they can be left intact, continuing to accumulate on a tax deferred basis much later into retirement.
No Impact on Social Security Taxation
Many retirees are finding that, in order to maintain their standard of living, they need to continue to work in retirement. The potential problem that creates is that a portion of their Social Security income may then become includable in their income tax calculations. A married couple in retirement can only earn $32,000 from all sources before taxes are also owed on Social Security income. One of the advantages of annuities is that their income is not includable as part of the Social Security tax calculation.
Guaranteed Death Benefit
Millions of investors lost as much as 40% of their retirement plan account values in the last market crash. For those who were brave enough to keep their money invested in the markets, they recouped their losses and more. It’s an unfortunate fact, that many investors didn’t keep their money invested and have yet to fully recover their losses. Throughout that whole ordeal these investors and their families were suddenly very vulnerable in the event of a premature death of the investor. The family would be left with only a fraction of what was accumulated, and, in many cases, a loss of principal. Annuities provide a unique layer of protection with their guaranteed death benefit which pays out, at a minimum the original principal to the beneficiaries. With some annuities, such as an indexed annuity or a variable annuity with special riders, even the gains can be protected against loss and includable in the guaranteed death benefit.
Guaranteed Lifetime Income
Since the demise of defined benefit, or pension plans, investors have had to rely on their own ability to accumulate enough funds that would generate an income they couldn’t outlive. Most studies have sadly shown that as much as 60% of people reaching retirement age have not saved nearly enough money to last a lifetime, at least without some major downgrade in their lifestyle. The “new normal” today will see most people delaying their retirement or working well into it. This is, perhaps, the biggest reason why pre-retirees are adding annuities to their retirement portfolios, because, as they are coming to realize, annuities are the only investment vehicle that can guarantee a stream of income that cannot be outlived. When combined with the income generated from other savings vehicles, annuity income can provide the added safety net and stability for a retirement portfolio that needs to include other growth or risk oriented investments.
Very few financial advisors would advise anyone to own an annuity unless it was in the context of a complete retirement strategy that included a well diversified, balanced portfolio. When the unique attributes of an annuity – its tax deferral, its safety, its guarantees, and it flexibility – are combined with a larger portfolio, it can greatly enhance its stability, reduce risk exposure, and provide long term security.