We all want to feel comfortable with our retirement investing choices. Our hard-earned and invested dollars allow us to enjoy that once-in-a-lifetime vacation, snowbirding, or just fun weekend trips. Don B., a 77-year-old Retirement Awaits reader, wants to know if a variable annuity with a guaranteed income is something he should consider for a portion of his portfolio. Is it a legitimate option?
Don, I like the way you phrased your question. Simply put, yes, they are a legitimate option. They are worth considering for the right situation. Of course, that leaves the issue of whether or not they are the best choice among all of your options. That answer is very individual and depends on what exactly you are looking for or wanting from the decision.
A word of caution to keep in mind: Variable annuities are unfortunately often oversold or pushed by salesmen when they aren’t needed, and they are very complex. Before you decide to buy one, it is important that you both understand how (or if) it fits your specific plan for retirement, as well as exactly how yours works.
Best Case For A Variable Annuity
Variable annuities with income guarantees are usually best suited for situations where you value the income guarantee but may not want to purchase an income annuity or still want some potential for growth. I’ll provide some context and explain below.
First, understand that income guarantees from annuities (variable or not) can be very valuable for a retirement plan and allow you to enjoy your retirement years a lot more.
For example, suppose your total retirement budget is $8,000 per month, of which $5,000 per month is for necessities and to be comfortable. Let’s say you and your spouse bring in $4,000 a month from Social Security. Securing that other $1,000 a month with a guarantee so that you know your base level of income is assured no matter what happens with your savings can go a long way to reducing stress for some people.
The “guarantee” applies to both the amount you receive, as well as the insurance company’s promise to pay it for your life so you don’t have to worry about running out of money. If that sounds too good to be true, well, in this case, it’s actually not. However, there are tradeoffs, which I’ll get to in a moment.
Pro Tip: Check out this calculator to get an idea of what this type of annuity might cost.
The simplest product that provides a guaranteed income is an immediate annuity. These are very straightforward. You give the insurance company a sum of money, and in return, they give you a payment stream for life. When you get a quote, you’ll be told the amount of your income payments and you’ll be told what it will cost you. No real mysteries or anything to dissect, although you may need to do some studying to understand how that compares to simply investing the money and crafting a withdrawal plan, but that’s another topic.
Now, the tradeoffs:
- Once you pay the insurance company for the immediate annuity, then that lump sum is no longer yours. For many, giving up a large lump sum is a significant emotional and psychological hurdle. “What if I buy the annuity, and then 3 years from now my parachute doesn’t open on my annual skydiving trip?” The feeling is often that the money would have been wasted because it can’t be left to heirs.
- You also then don’t have that lump sum of money sitting in your account that you could access if you needed to.
- What if you buy the annuity and then the market climbs for the next 10 years? Will you regret not having that money to invest?
These concerns don’t make income annuities bad choices. In fact, they often are great choices for a portion of your savings, such as in the example described above. However, they do often keep people from using them even when they otherwise make sense.
Variable annuities may alleviate some of these concerns. Your contributions are invested into your choice of investment accounts (from among options in the contract) within the annuity so it may still grow over time. You may also be able to withdraw from it (usually with penalties), so you won’t necessarily give up the amount used to buy the variable annuity.
However, variable annuities are much more complex than immediate annuities. They vary widely between contracts and issuers. It is very easy to be confused by a contract, or perhaps worse, think you understand it when you don’t. It’s too in-depth to fully explain here, but before you purchase one, you need to make sure you fully understand your contract, including:
- The difference between your contract value and your benefit base.
- How each may grow and how those values relate to each other.
- What impacts your eventual payment stream when you decide to turn payments on.
- How withdrawals impact your contract value and income guarantee.
Variable annuities won’t be right for everyone or for every situation. Even when they are right, they seldom make sense for your entire portfolio. The key is to make sure you understand what you are buying, why you want to buy it, and have compared it with other options such as income guarantees from immediate annuities.