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What is a retirement annuity? What are the pros and cons of retirement annuities?
An annuity is an insurance contract that offers you regular payments for the rest of your life. There are pros and cons of retirement annuities, and understanding them will help you to make the best decision for yourself.
Keep reading for our retirement annuity pros and cons list.
Retirement Annuity: Pros and Cons
An “annuity”—or “long-life insurance”—is a contract with an insurance company for regular payments as long as the purchaser lives.
For example, as of mid-2018, a $1,000,000 premium for a fixed lifetime annuity guaranteed a 65-year-old male an annual income of $67,000. (Thus, to earn out the premium, the 65-year-old would have to live at least another 15 years.)
There are several pros and cons of retirement annuities, which we’ll discuss below.
Annuities come in a variety of shapes and sizes. One important variation is the “variable” annuity. This is an annuity whose payments adjust based on the underlying asset (typically a mutual fund). For example, if the stock market rises and the underlying fund posts an above-average return, the annuity payment will rise (by the same token, if the market falls, so does the payment). A variable annuity can be an inflation hedge, because a fixed-payment annuity doesn’t adjust to rising prices.
Here are the pros and cons of retirement annuities:
The biggest advantage annuities have over investing your nest egg yourself is the guarantee that you won’t outlive your money. If you’re a particularly risk-averse senior, you might consider devoting some or all of your savings toward an annuity.
There are four primary disadvantages of annuities.
1) Bad for Bequests
Retirees with solid income-producing assets might choose to forego an annuity, even if it offers the promise of a higher annual income. This is because, if the retiree uses all of his savings to purchase the annuity, there will be nothing left over for bequests to family or charity.
Even with a variable annuity, the annuitant’s annual income is relatively static. This can become burdensome if circumstances change and the annuitant wants to increase his or her consumption.
Say, for example, a 65-year-old purchases an annuity, then suddenly discovers he’s terminally ill. He might like to cross some expensive items off his bucket list—traveling the world, let’s say—but he wouldn’t be able to increase his consumption drastically: he’d be constrained by his annuity payment.
Along with the premium, costs of annuities can include the fees and expenses of the seller and commissions for the selling agent. These extra expenses can make annuities a much less attractive investment.
4) Tax Inefficiency
Variable annuities especially, due to their turning capital gains into ordinary income, expose annuitants to greater tax liability. It’s also important to note that partial annuitizations of retirement accounts doesn’t negate required minimum distributions (the minimum amount retirees must withdraw from their account after age 72) from the non-annuitized portion of the account.
The above pros and cons of retirement annuities will help you to decide whether an annuity is right for you.
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