Why Retirees Are Using Annuities Instead of Early Social Security

by Lisa Cintron on 20 October 2010 3 comments

As some Baby Boomers reach retirement age, they have postponed taking Social Security until later in their lives. Social Security attempts to average benefits over the expected lifetime remaining for its participants. Taken in concert with recent economic problems — which have caused some senior citizens to return to work — many senior citizens have become more interested in how annuities can fulfill their retirement investment goals.

How has the recession impacted retiree investment choices?

Many responsible senior citizens (who own stock) have calculated their retirement income based on an expected rate of return. When the subprime mortgage crisis surfaced, the Dow Jones Industrial Average (DJIA) declined by 46.22% from a near-term high of 14,164.53 on October 9, 2007 to a near-term low of 6,547.05 on March 9, 2009. This stock decline destroyed much of the value in investment portfolios, which had been saved for retirement purposes.

Stock investments can require years before they return profits. Unfortunately, many senior citizens don't have a lot of time to wait for their stock portfolios to regain their value. Some have "unretired" and returned to work; others are considering different investment options, like annuities.

Postponing Social Security

Social Security check amounts are calculated using an average of health, life expectancy, and wealth for beneficiaries based on a "normal" retirement age according to their birth dates. If you retire "before" your "normal" retirement age, then Social Security reduces your benefits by five-ninths of 1% for each month before your "normal" retirement age (up to 36 months). For example, if you retire nine months before your "normal" retirement age, then your Social Security benefits would be reduced by 5%.

Therefore, if you retire at age 62, then the government calculates that you will have a longer period of time to enjoy the benefits, so it reduces your benefits. Generally, if your health and wealth are better than average, it makes sense to retire later; if your health and wealth are worse than average, it makes sense to retire earlier.

These are the most common reasons to wait to draw on Social Security:

  • You have good health.
  • You have ample savings.
  • You are single.
  • You are working.

If you work, Social Security benefits are reduced when you make more than the "annual earnings limit" (AEL) — the government deducts $1 for every $2 earned above the AEL. Thus, some seniors must carefully estimate whether continuing to work while receiving Social Security benefits makes economic sense.

ARTICLE CONTINUES BELOW

What are the different types of annuities?

An annuity is an investment whereby an investor deposits a lump sum with an insurance company, which guarantees a retirement income stream.

  • Deferred Annuity: Payments begin at later date
     
  • Equity Indexed Annuity: Rate of income stream depends on market index (i.e., the Standards & Poor 500)
     
  • Fixed Annuity: Fixed income stream for fixed period of time
     
  • Immediate Annuity: Payments begin immediately
     
  • Variable Annuity: Rate of income stream depends on value of underlying securities.

How do annuities help retirees with monthly income?

Retirement can be a shock if preparations were not made ahead of time to ease the transition. While you work you maximize your income; once you retire, you conserve your wealth to make it last the rest of your life. An annuity helps retirees ration wealth by replacing the former working income with a retirement income. Retirees can adjust more easily to retirement knowing that they are generating annuity income that covers their expenses.

In a certain sense, an annuity is a reverse life insurance policy. While a traditional life insurance policy provides a lump sum payment for premature death, an annuity provides retirement income for a long life.

How can annuities help retirees with lifetime income?

Actuaries calculate that the average person who is aged 65 has an average life expectancy of 20 years. With an annuity, retirees can designate the time frame that this investment covers in order to provide a "guaranteed income for life." An annuity ensures that invested money is working for the retiree; it can be purchased in conjunction with other investments — stocks, bonds, and real estate — to provide liquidity and security.

Basic procedures for annuity investing

After carefully researching annuities and determining which type of annuity provides the desired monthly income — "Fixed" versus "Variable" rate of returns, and "Immediate" versus "Deferred" payment schedules — a retiree should decide on a specific company and product to invest in. Finally, the senior will be required to pay a fixed lump sum to an insurance company for the benefit of receiving the annuity's guaranteed income stream for a designated period of time. It is that easy.

This is a guest post by Lisa Cintron. Lisa is Executive Vice President at AdvisorWorld.com, a social community of consumers and financial advisor who engage in conversation to help you research financial topics.

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rprather

I feel compelled to note that often annuities are not a good choice for people. Sure, there are instances when perhaps an annuity may be a good choice, but often they are pressured on older people who don't know they are being taken advantage of.

Annuities are, for the most part, an insurance product -- they are more insurance than investment. I say this because I think the only instance when someone should buy an annuity is when early in their retirement (or near retirement) they fear they will outlive their retirement savings by decades. Or perhaps they want to make sure their spouse is provided for (however, there are other ways to accomplish this).

Most importantly, there are huge up-front costs and commissions associated with the sales of many (most!) annuities. And then if you want to get any of your money out later there are often large fees associated.

Annuities are illiquid and are not at all without risk of losing value (even if they adjust for inflation).

Be very careful! Don't be wined and dined into an annuity. Especially if you're already quite old. Yes, sometimes it may take years for your investments to recover from losses, but that's why you slowly move more and more of your investments into less volatile bonds as you start using your retirement savings. You shouldn't have money you're going to be spending in the next 5-10 years in the stock market. But you should always be in the stock market! :-)

Please always only work with a Fee Only (no commission!) advisor.

Guest's picture

I beg to disagree PRRATHER, annuities can be a good choice. “Trust, but Verify” is great mantra for any confident person. Acquiring the tools to verify what you read and hear about annuities is essential. Products, and the advisors who recommend them, must verify against your knowledge and tools. Only then do these people and products earn your trust. Become a smart buyer- empower yourself to verify before you trust. To use an analogy, when you buy a home, it is wise to bring a buyer’s agent to represent your interests in a purchase until you how to ask the right questions to get all the necessary information about the property. But after you’ve bought and sold many homes and acquire more specialized knowledge in the field, you can feel confident dealing directly with the seller’s agent and representing your own interests.

Guest's picture

Every retiree has his own savings that they need to turn into a source of income. And annuity is designed exactly to do so. That’s why there is a logical appeal to annuity. But in my view, all annuity products might not be equally suitable for people of all ages. I think fixed type of annuity suits most with the people reaching their retirement, where as relatively young people should invest in a variable annuity.