Baby boomers are retiring at the rate of 10,000 people every day and will continue to do so for the next 19 years. That means 3,650,000 people will retire in the next 12 months, or 69,350,000 people over the next 19 years. Some have prepared well for retirement, but a lot haven’t. Regardless of which group a boomer is in, many tend to share a common worry, will they outlive their money in retirement?
It’s easy to see why annuities are being so heavily marketed given the numbers of people retiring and how few boomers are well prepared for retirement. I felt it was time to write two posts on annuities; one that provides a high level overview and one that begins to address whether they are a good retirement vehicle or not.
Annuities are an insurance product that pays income, usually to the person who bought it. There are two basic kinds of annuities, deferred and immediate.
Deferred Annuities: Deferred annuities are usually structured for people who want or need to invest money over a period of time (years, decades, etc.) until they are ready to take withdrawals in retirement. A deferred annuity builds money over a long time period such as a 401(k) plan or IRA.
Immediate Annuities: Immediate annuities are usually bought by someone near retirement age with a single payment such as from the proceeds of a home sale, an IRA rollover, etc. Once the annuity is purchased, the owner begins to receive payments from the annuity within a short time frame (a few weeks, months, or within a year).
Deferred and immediate annuities are then structured by the type of investment within them. The two types of investments are fixed and variable.
Fixed Annuities: A fixed annuity provides a steady income stream or rate of return for a specified number of years or the rest of your life. Your money is invested in government securities or high grade corporate bonds.
Depending on how the annuity is structured, the interest rate is either locked in for the life of the annuity, or you may have the option to take advantage of periodic market adjustments. If you buy one that allows you to make periodic market adjustments, it’s important to know, and compare, what the differences in management fees (expenses), surrender charges and overall flexibility are compared to an annuity that doesn’t.
Variable Annuities: A variable annuity gives the purchaser the ability to participate in the upside gains of the stock market by investing in a range of investment options similar to mutual funds. If the market goes up, the funds in a variable annuity account increase, however they also can decrease if the market goes down.
An equity index annuity is a variation of the variable annuity in that it ties the performance to a specific index, such as the Standard & Poor’s 500 index. The insurance company assembles a portfolio of stocks and bonds that correspond to the chosen index. If the index performs well, the annuity owner’s gains are capped to a predetermined participation rate ranging from 50% to 90%. This means if the market is up 10%, the annuity owner makes 5% to 9% and the insurance company keeps the balance of the gain. In exchange for this participation rate, insurance companies typically guarantee a minimum rate of return of say 3% (this varies by company) when markets fall.
What do you think about annuities? Share your thoughts, questions, and experiences with us in the comments section of our blog or on our Google + or Facebook pages. I’d love to hear from you!