Annuities can provide helpful income streams in retirement, but not everyone needs them. In fact, for some retirees, annuities may be more trouble than they’re worth.
For one thing, annuities can be expensive and loaded with fees, making the products difficult to compare if you’re shopping for one. Plus, investors are banking on the annuity seller’s solvency. If the insurance company selling the annuity goes out of business, the policy ends and so does your guaranteed income stream.
[See: 7 Important Things to Understand About Annuities.]
David Schneider, founder of Schneider Wealth Strategies in New York, says there are two dominant cultures in financial planning, those on the insurance and annuity side, and those on the investment side. “The folks on the investment side frown on them, and the folks on the insurance and annuity side think that almost everyone should have an annuity,” he says.
Which category you fall into depends a lot on the kind of investor you are and how well you’ve planned for retirement. If you’re near retirement, here are five reasons why you might be just fine passing up on an annuity.
You’re comfortable investing. One of the advantages of an annuity is that someone else is responsible for turning your hard-earned retirement savings into regular income, but if that’s a job you’re comfortable with, why farm it out?
Do-it-yourself investors who are at ease with stock market risks and understand that markets fluctuate probably don’t need to subject themselves to the higher fees that are associated with variable annuities, Schneider says. “The traditional investment portfolio is likely to produce as good or better results than these annuities,” says Schneider, who advocates investing in a mix of stocks, bonds, mutual funds, real estate and other vehicles.
You have a retirement plan and can stick to it. People with a retirement plan in place are more likely to understand what they need to do to make their nest eggs last, according to a May survey on retirement income literacy from the American College of Financial Services.
The survey found that 36 percent of respondents who understood their income needs felt more confident they could manage their own investments throughout retirement. “It is critical to have a plan in place in order to ensure you are on track for secure retirement years,” says David Littell, co-director of the New York Life Center for Retirement Income at the American College of Financial Services.
The ability to stick with a financial plan is even more important, says Marc Horner, wealth advisor and founder of Fairhaven Wealth Management in Oakbrook, Illinois. “You can’t get cold feet when the market goes through its gyrations and abandon the investment strategy that is designed for the long term,” he says.
[See: 7 Things You Need to Understand About Your 401(k).]
Your financial plan includes spending. A good financial plan is about more than having the right investments for your portfolio, Horner says.
The other side of the ledger — spending — also needs a game plan. “Spending can quickly torpedo the best crafted financial plan. Spending probably doesn’t get as much attention as it should,” Horner says. Living frugally can go a long way to keeping your nest egg intact, but in the early years of retirement, people often spend more because retirees are busy checking off their “bucket list” of activities.
Where spending is concerned, financial planners typically budget for 70 to 80 percent of the person’s pre-retirement working income. “If you made $100,000, you want to budget for $70,000 to $80,000,” Horner says. “But this is my 18th year of doing this, and we see (retirees) spend every bit as much as they did when they were working.”
Andy Whitaker, a financial planner at Gold Tree Financial in Jacksonville, Florida, says retirees who don’t use annuities should establish a spending plan that includes either living on only the earnings from invested dollars or spending investments down to zero by a specified age.
You can live on 3 to 5 percent of assets a year. How much money each person needs in retirement varies, but a general rule of thumb is to live off of a 3 to 5 percent annual distribution indexed to inflation, with many advisors splitting the difference and saying retirees should shoot for 4 percent. “That distribution rate is considered indefinitely sustainable,” Horner says.
“It’s reasonable for people to assume that if you can get along on a 4 percent withdrawal from your assets with an inflation adjustment that you’re probably at a decent financial position,” Schneider says. “But again, it’s just a rule of thumb. It’s not a substitute for a comprehensive financial plan.”
What does a 4 percent withdrawal rate look like? Horner says someone who needs $40,000 a year to live on should have a $1 million saved.
Need a little more income? For $75,000 annually, a retiree needs $1.87 million in savings that earn a fixed return of 4 percent, Whitaker says.
Investors also should account for market and earnings fluctuations. “If the investment loses money for two, three or four consecutive years initially and the investor is withdrawing 4 percent, they stand the significant risk of running out of money before they die and not leaving any of the original funds to heirs,” he says.
[See: 9 Dividend Aristocrats for Stable Income.]
You have sources of stable income. People with several sources of sufficient, stable income that they can rely on consistently, such as Social Security or a pension, likely won’t need an annuity, Horner says.
Having a part-time job, income from hobbies or real estate investments that pay rental incomes are all examples of ways to generate more money in retirement. “The more predictable income that a person has in their financial plan, the stronger that financial plan is going to be,” Horner says.
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5 Reasons You Might Not Need an Annuity originally appeared on usnews.com
