Saving for retirement can be difficult—that's just reality. This may especially be the case when investors have expenses right now that need addressing. Fortunately, there are several different ways that Americans can save for retirement, including employer-sponsored 401(k)s or individual retirement accounts (IRA).
But depending entirely on these traditional vehicles may still leave retirement planning open to risk. What if a stock market downturn occurs close to a client's target retirement age? Much of their IRA or 401(k) savings may sink alongside the greater market.
Portfolio diversification should be a priority for retirement savers, and financial advisers have a role to play educating clients about all potential investment vehicles. That's where annuities come into play, which can provide fixed income, help protect lifetime income and better mitigate risk. Let's explore in greater detail.
The state of retirement saving in America
To understand the value that annuities can bring to a retirement portfolio, it's worth looking at the challenges faced by Americans today.
According to a 2019 John Hancock survey, saving for retirement was the top money woe for respondents. In all, 51% of retirement savers were behind schedule and just 14% said they were "very" knowledgeable about retirement saving strategies.
Most understand the tall task ahead of them: 71% of respondents said they would need to replace at least 50% of their income in retirement. Of that number, 39% said they will need to replace more than 75% of their current income.
Few have that level of savings built up. The most current research from the Economic Policy Institute shows that for a family with a head of house age 44-49, median retirement account savings totaled only $13,000. According to research cited by CNBC in 2019, the annual cost of living in retirement exceeds $50,000 in all 50 states.
How annuities can add performance and diversify portfolios
So how can Americans get their retirement savings back on track? In some cases, it may take a somewhat radical reimagining of what it means to financially plan for retirement.
To now, most — if not all — of the focus has been on saving for retirement. But what if there was a way to supplement this strategy and limit risks while also maximizing preparedness.
These are the advantages that annuities can deliver through lifetime income and reduced portfolio risk.
What is an annuity?
Basically, an annuity is a long-term contract with an insurance provider. Payments toward this agreement are converted into retirement income that is then distributed once the annuitization period begins.
Investors may either make one lump sum payment or multiple smaller payments, depending on the annuity type. Similarly, there are a number of different ways in which clients can structure the exact cadence of how they receive money throughout the annuitization period, which can begin immediately upon signing the contract or at a later date.
What are the benefits?
Annuities (including the specific subcategory of retirement annuities) have been a popular financial instrument in America for decades. They are an attractive investment for one big reason: Annuities can be used to provide guaranteed lifetime income to depend on throughout retirement.
The upside to investing in an annuity is clear. The ability to convert part of current retirement savings into a fixed stream of income, whether monthly or annually disbursed, can deliver greater peace of mind and financial security for retirees and their families.
- Give investors a measure of insulation against equity market risks that may affect 401(k) or IRA savings.
- Can help clients ensure that they don't outlive retirement savings.
- Offer a number of ways to personalize the investment, whether through a death benefit or annual adjustment for inflation.
Clients may commonly struggle with how to replace a large portion of their income, especially if retirement savings decline broader with the larger market. The advantages of annuities are clear: With lifetime income, you can worry less and save more even.
Yet, as with any investment, there are some potential downsides to consider when considering annuities. For example, some may have higher fees, while tax treatments can differ and early withdrawals may be limited. Ultimately, it's important to walk clients through all their options.
What types of annuities exist?
Still trying to show a client how an annuity might fit into their retirement portfolio? Fortunately, there are several different types of annuities, each with its own advantages. Some common options include:
- Fixed annuity: Provides a fixed interest rate and high level of predictability. Payment choices are flexible and funds can typically be accessed at any time.
- Index annuity: Interest is tied to performance of a stock market index (such as the Nasdaq-100). Even if the market declines, principal will be protected. This option can open the door to higher growth.
- Variable annuity: The rate is linked to professionally managed funds, like a mutual fund. The value can increase or decrease depending on the underlying fund. Often, clients will have the option to purchase additional protections for principal.
- Indexed variable annuity (IVA): This is a fast-growing category of annuities. Also called Registered Index Linked Annuities (RILAs) these investments can help you diversify your retirement portfolio while giving you opportunity for growth, and provide a level of protection against market risk..
- Immediate annuity: Think life insurance policy, but in reverse. The investor commits a lump-sum payment upfront that is then disbursed in regular installments that can begin in as soon as one month.
- Deferred annuity: Payments from such annuities are held until a future date. This is great for pre-retirees who don't need money now, but desire greater lifetime income once they leave the workforce.
- IRA annuity: Stocks and bonds aren't the only assets that can be invested in through an IRA. Clients can also purchase annuities through their account, allowing for tax-deferred growth. However, there are many pros and cons to consider with IRA annuities. For example, annuity money already grows tax deferred, holding it in an IRA might be redundant. On the other hand, if you’re closer to retirement, such an investment could give you access to guaranteed income.