There’s a rumor going around that you won’t need as much money during retirement as you do during your working years, but let’s just think about that for one second. What day of the week do you spend the most money? The day that you aren’t working. For most people, that day is Saturday. You might think of retirement, then, as one vast horizon of endless Saturdays. So how do you fund a seemingly endless shopping spree?
Retirement is supposed to be the reward for a job well done. If you’ve saved your money, then you deserve to enjoy the fruits of your labors. The problem is getting that predictable income. Is an annuity is the right solution? This is a quick read that will alert you to three major traps with tips for how to avoid them.
TRAP #1 TAKING A DO-IT-YOURSELF APPROACH
Investors who choose the do-it-yourself option might be looking for a simple solution to the complicated problem of running out of money. By choosing a fixed annuity, it’s possible to put your savings in an investment vehicle that has principal guarantees with a fixed rate of return. This option usually gives you 10% free withdrawals a year from which you could cobble together an income. There are two major pitfalls with this approach.
First, should you need more income than 10% of your money, there could be a steep penalty charged by the insurance company, especially during the early years of your annuity. Those charges can be as high as 10 percent of the account value.
Second, once the money starts to run out, no warning lights or buzzers go off, and there’s no safety net in place. Once the money in the account is gone, it’s gone. With fixed annuity rates averaging around 2 to 3 percent, how will your money outlast the complications of increased longevity and the rising cost of health care?
Today’s fixed indexed annuities might have more working parts, but they are designed to address the multiple issues facing retirees today. Accounts created by income riders are guaranteed to continue paying income even if the actual account runs out of money, and most newer FIAs come with some long-term care protection built-in.
TRAP#2 EXPOSING YOURSELF TO THE DIRECT MARKET LOSS
At the other end of the spectrum, we have investors who still want to benefit from the action of the stock market. If you ask your broker what kind of annuity to get, he or she will likely recommend a variable annuity, because this kind of annuity is a securities investment. It can benefit from an improving market and still pay out an income. There are several pitfalls here to be aware of:
First, some variable annuities guarantee the income whereas other variable annuities do not, and those guarantees come with lots of red tape. If your account loses too much money or you withdraw too much income, then all the terms you agreed to could change.
Second, the money you put into the investment is not guaranteed. This is known as a principal guarantee, and some annuities do offer this. Fixed indexed annuities, for example, offer a more secure way to benefit from market gains because they use an indexing method to calculate returns. If the market does great, you receive a percentage of the earnings. If the market does poorly, you do not see your account go down. With a variable annuity, however, you CAN lose money in the stock market and your actual account value can go down even if you are paying extra for income rider guarantees. If you have this kind of annuity, please reach out to us. We can have your annuity tested to see if better options exist
TRAP #3 NOT UNDERSTANDING THE INCOME RIDER
As we said earlier, the challenge of not outliving your money is a complicated one, and income riders are complicated features that you can add to an annuity at the time of purchase. Problems arise when these things aren’t explained fully to the investor. To avoid the two biggest pitfalls you want to ask your advisor two questions:
- Question One: What is the fee for the income rider? With variable annuities, in particular, the fees on these products can really add up. We’ve seen investors who owned variable annuities when they didn’t even need the income and had no idea they were paying for a rider.
- Question Two: How can I get my money? Some annuities are annuitized once you start taking the income. That means you lose access to the value of your account and the money can only be received as monthly income. Fixed indexed annuities with income riders offer more flexible options so that you can decide after a period of time whether or not you want to take your money out.
The problem of retirement income is a complicated one. To solve it correctly will likely require a bit of research and the guidance of a qualified professional. We’re here to help. If you have questions about an annuity you’re considering and want to have it tested against other annuities that are similar, fill out our simple form and one of our advisors will get back to you, no fees and no strings attached.