Annuities: Why You Need to Know How They Work
In the old days, before the growth of 401(k) plans, many employers would have paid you a pension that lasted your lifetime. The employer was obliged to pay you your monthly benefit no matter what happened to the stock market. Today, while some people are fortunate to still have those types of pensions, most of us must make our own key decisions and decide how to manage our own funds and how to cope with the three big "what ifs" of retirement. What if I live too long, what if my investments lose money and what if inflation hurts my investments?
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Managing Your Retirement Assets
Let’s say you have built up a retirement fund of $250,000 by the time you are age 65. Few realize that you must make that money last for perhaps 20 or 30 years after you stop working. That’s how long the typical person will live. There are two ways to make your fund last for the rest of your life:
Manage your assets while taking take systematic withdrawals from some of your accounts in amounts that you estimate will allow the rest of your assets to last you for your lifetime. Or,
Take some of your money and purchase an immediate annuity with those funds so you provide yourself with guaranteed income payments for the rest of your life - while managing the balance of your assets for the benefit of your heirs or to address future inflation.
You may decide that the best way is to use a combination of both of these by managing your own retirement fund until the time seems right to convert some of your money into an immediate income annuity.
When is an Immediate Annuity Right For You?
If you have retirement expenses which are not covered by monthly pension and Social Security benefits. An immediate annuity can guarantee a regular monthly payment for the rest of your life. On the other hand, if you have a large enough income to pay all your expenses from other sources, you may not need an income generating annuity.
If you have every expectation of living a long life you may benefit from purchasing an immediate annuity. Most of us don’t know and can only make our plans based on reasonable expectations. If your parents and siblings are living long healthy lives you may have longevity in your genes. If you have a chronic or terminal medical condition and you know you won’t live for many years, you may want to spend the lump sum instead of buying an income annuity.
You Want the Certainty of Knowing You Won’t Outlive Your Means
An immediate annuity is the best way to make certain you will get payments for the rest of your life, no matter how long you live. Some people worry they will die early. You can structure your income annuity so that it is guaranteed to pay benefits to your heirs for at least 5 or 10 years, even if you die before then. Some people worry about having a lot of money tied up in an income annuity. Some financial advisors and insurance agents may say they can do better for you than an immediate annuity. Make sure you understand the risks involved in managing your money if you decide to skip the annuity.
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At What Age Should I Buy My Immediate Annuity?
Some people suggest that you wait until you are between ages 70 and 80 to buy your annuity, because you are older and your life expectancy at that time is shorter so you should get a higher income from your deposit. Just make sure you don’t use up too much money before then. You may not have enough left to buy the income level you need.
What Should I Consider When Choosing an Annuity Provider?
The two main criteria for comparing annuity providers are price and safety. You will want the best price among the safest companies. To find out which companies are safe, research their credit ratings. Remember if an insurance company goes under, state insurance guarantee funds may continue to pay your annuity up to the state’s maximum amount. Once you have a list of companies with good ratings find out how much income they will provide you for your deposit.
How Much Annuity Income Should I Purchase?
First, estimate your annual expenses in retirement. Remember that some of your expenses will go down. You won’t have to pay Social Security taxes, you won’t need to pay work-related expenses, and you probably won’t need to save. However, be prepared for some expenses to go up.
Next subtract your annual Social Security and pension income from your estimated annual expenses. If you decide to buy an annuity, it should cover those expenses which are not covered by Social Security and pension benefits.