Since there’s no such thing as one-size-fits-all financial planning, some products will be a better fit for some people than others.
For those who sleep better believing they have some guarantees in place, annuities may have a place in their retirement strategy. Before considering this investment vehicle, you’ll want to know more about your options.
An annuity is an insurance product originally created to prevent people from outliving their money by providing guaranteed income until death. That’s still one primary purpose for some annuity products, but they’ve become far more diverse in their offerings and functions. Still, you have to pay for each bell and whistle, and that can be a considerable knock on these assets. The term “guarantee” can also be misleading. The guarantee of an annuity is only as good as the company offering the investment so you’ll want to do your homework on the both the provider and the terms of the annuity itself.
Fees, which tend to be higher than those of other retirement investments, are also an important consideration. It’s a legitimate concern regardless of the type of investor you are, but if you’re a more aggressive investor the fees may overshadow any benefits. Still, for some, the higher cost is worth the peace of mind.
If an annuity is suitable for you, there’s no reason to pay for guarantees you don’t need, so shop carefully. Some terms you may run across when you look at annuities include:
- Guaranteed minimum income benefit: This feature of annuity provides what the name suggests, a minimum payment amount when it comes time to annuitize. (Annuitize, simply put, is the practice of switching from paying into the investment to receiving payments from the investment in agreement with the terms of the contract you sign.) It typically guarantees an annual growth rate based on your initial investment.
- Guaranteed death benefit: Upon your death, your beneficiary would receive a pre-specified dollar amount, either a percentage or some other lump sum determined by your annuity contract.
- Surrender fee: This is the cost of early withdrawal from your annuity. Terms of the contract will state how long you must wait before you can start receiving payments without being charged a penalty.
For younger investors, annuities are generally less appropriate because high fees would likely put a tremendous dent in the lifetime earnings of the investment in exchange for guarantees that aren’t needed for decades. In short, an annuity could really cramp compounding for a younger investor.
For investors seeking added stability as part of a diversified array of retirement vehicles, there are several ways to incorporate an annuity into your retirement strategy, including:
- A 401(k) annuity option: A few 401(k) plans contain an annuity investment option. If your plan offers one, you could elect to place your contributions directly in the annuity; many are designed to accommodate such a move about 10 years prior to retirement. However, you likely wouldn’t be able to roll that money to a new 401(k) plan if you changed employers.
- Changing jobs: You can roll your 401(k) dollars to an annuity. Leaving your employer for any reason—a new job, layoffs, getting fired or simply quitting—constitutes separation from service, so you could roll over part of your vested balance into an annuity under any of those circumstances. Also, upon retirement, you could elect to roll over part of your balance into an annuity; if your plan includes this option it may also offer discounts.
- Independent investing: You can invest in an annuity independently, unrelated to your 401(k) savings.
For the record, I’m not a fan of annuity options for most investors. I believe the fees often overshadow the benefits and I have growing concerns that sales goals may win out over best-for-the-investor decisions made by the agents who sell them. That said, there are reputable offices offering annuities and there are investors who could benefit from this option. Still, it would be very rare to encounter someone who is best served by investing all retirement dollars in an annuity. They should be part of a larger strategy that also includes traditional 401(k) investments and more.
If you decide to invest in an annuity, be sure to do your due diligence. Remember the guarantees are only as stable as the company offering them, so purchase from an insurance company with a good credit rating and a good balance sheet. Also, compare fees and expenses among several annuity products offered by several companies to ensure your selection has reasonable fees. Also, speak with your financial professional to evaluate any tax considerations or long-term planning considerations before moving forward.
Scott Holsopple is the president of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.
Nothing in this article should be construed as tax advice. Contact a qualified tax professional to discuss any tax matters relating to your retirement plan and investment option.