Should You Consider an Annuity for Retirement?
Annuities are a popular and well-established method of providing a secure retirement income. They may not, however, be suitable for everybody. Below, we've provided our answers to a few of the most common questions asked by people approaching retirement who are considering this option.
What Is an Annuity?
In its simplest form, an annuity is guaranteed income for life provided by an insurance company in exchange for a cash lump sum. For example, an individual may exchange the funds that they have built up in their pension fund over their career for a retirement income.
These days, however, you don't necessarily have to pay for your annuity all at once. Many providers now offer installment options for greater flexibility. You can also defer your annuity payments to a later date, allowing your lump sum to accrue further investment returns in the meantime. These returns may also qualify for tax relief in certain circumstances.
Keep in mind that this article is for informational purposes only and is not a replacement for real-life advice, so make sure to consult your tax, legal, and accounting professionals before modifying your tax strategy.
How Are Annuities Calculated?
The amount of annual income that can be purchased for a given lump sum varies according to the age and sex of the individual concerned. In some cases, lifestyle factors, such as smoking history or geographical location, may also be considered.
Using this information, the insurance company will calculate an average life expectancy figure based on actuarial data from millions of people and determine how much it will cost to provide the income you require for that period, keeping in mind the investment return they expect to make on your funds.
What Happens to My Annuity When I Die?
Historically speaking, buying an annuity was more or less a straight bet against the insurance company. If you died sooner than expected, they won. If you lived longer, they lost.
Now, though, a variety of options are available. Annuities can be structured to provide guaranteed payments for a fixed period—commonly 10, 15, or 20 years—and these payments will continue regardless of the death of the annuity holder (annuitant). These types of policies also allow the annuitant to nominate a spouse or other person to receive the remaining payments on their death. If an annuitant dies before a deferred annuity has become payable, a lump sum may be payable to a named beneficiary.
Who Shouldn't Buy an Annuity?
Annuities can be a great option for some, but they're not universally popular, and there are several reasons why they may not be right for you.
One of the much-touted advantages of annuities is the security they provide against the dreadful prospect of running out of money if you live to an old age. However, if you're confident that you have ample funds and/or have sound reasons for believing that your life expectancy may be limited, this may not be a concern. If that's the case, there may be other investment options out there for you.
It's also worth noting that the real purchasing power of fixed incomes, such as annuities, inevitably declines year after year. In addition, there's no guarantee that inflation won't skyrocket in the future.
Maybe you enjoy actively managing your money and prefer no-strings, low-cost investments. For you, the prospect of tying up a large chunk of your capital in exchange for a predictable, albeit safe, return is unappealing. It's true that annuity contracts are theoretically reversible, although the costs associated with the surrender process may make this an unattractive option.
Who Should Consider an Annuity?
Annuities are primarily designed for people who are not used to dealing with large sums, perhaps worried about their ability to budget, and nervous about relying on the stock market. They are also for people who have neither the time nor the inclination to master the intricacies of investing their own money.
Buying an annuity is a major financial decision that can profoundly affect your quality of life in retirement. Whether you find the idea attractive will largely depend on your personal circumstances and your attitude toward risk and investments in general.