There are many investment tools to consider when planning your retirement. In addition to stocks, bonds, real estate, and other possible vehicles, annuities can play an important role as a potential source of income.
Just as your investment portfolio should be properly diversified over the years that you save, your retirement income should also draw from a variety of sources. Guaranteed income annuities can provide a reliable income stream to complement more traditional (and risky) investment properties.
Although there are several varieties of annuities, the most commonly used for retirement savings is the Deferred Income Annuity (DIA). DIAs hold several advantages over immediate annuities, which include higher potential returns, varied interest rate exposure, confidence in the face of uncertain market forces, and a solid way to reduce risk.
How do DIAs work?
DIAs turn a slice of your savings over to an insurance company, which agrees to pay it back in lifetime income. The deferral period, which is the time that elapses between when you make your first investment and when the insurer begins to pay you back at a higher rate, can last anywhere between two and 40 years. If you add more money to the annuity, the income payments increase over time. These tools are particularly useful if you have contributed the maximum on your 401(k), 403(b), IRA, or other employer-sponsored savings plan.
They provide certainty.
Amid the volatility of the markets, annuities represent an oasis of calm, a sense of security that at least one portion of your retirement income safely waits for you. A DIA establishes guaranteed income despite whatever curveballs the market may toss your way. This peace of mind can provide flexibility with other assets and allow for some experimentation with stocks, bonds, and similar options.
They protect against risk.
When you incorporate annuities into your asset allocation, you have an effective brake to apply when the risk gets going too fast. A diverse mix of stocks, bonds, and income from a guaranteed annuity determines how conservative or aggressive your portfolio will be.
In addition, there are other ways an annuity can help alleviate risk:
A guaranteed income stream provides a cushion against downturns in the market that could adversely affect your retirement portfolio.
The longer you live, the more money you can receive, thanks to what’s known as longevity risk pooling (or mortality credits). Assets from annuity holders who have shorter life spans may remain in the “mortality pool” to provide payouts for those who live longer.
Annuity payments also help protect against the possibility of running out of money prematurely should you draw too much too quickly from your savings.
They are a key part of a diverse portfolio.
As you set up your retirement plan, be sure to cover your basic expenses (food, healthcare, utilities, automotive, and so on) with income that’s assured—Social Security, pensions, and annuities—so that your longevity (and that of your spouse) is not a potential financial liability. This frees up your investment portfolio to be used for discretionary spending such as hobbies, vacations, gifts for the grandkids, and so on.
A conservative portfolio might have 20 percent stocks, 60 percent bonds, and 20 percent annuities; a moderate package could include 40 percent stocks, 45 percent bonds, and 15 percent annuities; and an aggressive approach would feature 60 percent stocks, 30 percent bonds, and 10 percent annuities. Whatever speed feels comfortable for you, annuities can play a helpful role in getting you to your destination.
Like any investment option, annuities have some downsides:
You give up access to any money you contribute toward an annuity until future payments begin.
While you are protected from market risk, you also forfeit market reward in periods of robust growth.
Annuities carry fees that may not apply to other investment options.
You retire only once: Plan ahead.
Since no investment tool is foolproof, be sure to do your homework and have proper planning tools in place:
Create a retirement budget that includes all potential sources of income, such as pensions, Social Security, and other investment options, including annuities.
Keep retirement account withdrawals to just 4 percent a year, adjusted for inflation.
Maintain an emergency fund in case of surprise expenses.
Above all, remember that you’re not alone on this adventure. An investment advisor is a valuable ally when you’re considering annuities as a part of your retirement plan. Our retirement calculators can be a useful tool to use to see how far you have left to go down this road.