If you know anything about investing you have probably heard about the 4% withdrawal rule. This rule, which for years was thought to be failsafe, says that you need to have invested enough money into your retirement accounts so that you can withdraw 4% of your savings every year and still have enough money to last you for 30 years. Indeed, this rule seemed to be sound until right around 2008.
What happened in 2008, as most investors know, is that the stock market crashed and millions of people saw there investments lose between 35% and 40% of their value in one day (actually in munutes). For many who had stuffed their hard-earned money into their stock portfolio it was a very rude awakening and seemed to call the 4% rule to task.
Since that time there has been one change that financial experts have been espousing and that is that people should start using annuities (in combination with a well diversified portfolio) in order to hedge their bets against another crash.
But what is an annuity and why should you consider using it for your retirement investing plans?
At its most basic, and annuity is simply a contract between an investor and an insurance company. The benefit of an annuity is that it can provide the investor with a reliable income stream during their retirement. What it requires is a lump sum investment, or a series of them, now.
There are three types of annuities and the type that you should choose will depend on where you are in your career and what your income needs are going to be when you retire. With these three types, fixed, indexed and variable, you can also choose an immediate annuity and begin receiving pay right away or a deferred annuity which will allow you to grow your investment account and thus your income potential in the future.
With a fixed annuity you’ll get a guaranteed return that is based on the current interest rate. These periodic payments will have a fixed amount that is based on the value of your account at whatever time it is that you start receiving income. You can set these up to pay over a specific amount of time or over your entire life (and the life of your spouse) with the caveat being that the longer the payments last, the less the specific payment per pay period will be.
If you want to earn a greater return an indexed annuity might be better for you. They guarantee a minimum contract value regardless of the S&P 500 index‘s performance (which they are based on). This return is usually lower however and in most cases is not going to be more than 8%.
Lastly there’s the variable annuity which gives you an unlimited return on earnings for investments that you make into the stock market, usually untypical mutual funds. With this type of annuity however there is also the risk that you can lose money based on how well your specific investments perform. This means that your income will vary with the rate of return.
There are a number of different options and features that come with annuities. For example, a variable annuity offers living benefits that can protect your account from losing its value, guarantee a specific minimum payment and also allow you to make large withdrawals without being charged any penalties. Many annuities also have what is called a ‘surrender period‘ which means that, for specific amount of time, there would be a penalty incurred whenever you withdraw money. Keep in mind that the more options that you get in your annuities contract the more fees that you will pay over the life of your annuity.
If you’re already a retired or very close to retiring you would probably do well to choose an immediate annuity so that you would be protected from outliving your money and also from any risks of what happens with the market. The downside here is that you will lose control of your investment. On the other hand if you’re 10 years away from retirement or more you should probably consider a variable annuity with the caveat being that you’re not in the minority of people who are taking full advantage of all of their other tax-deferred retirement opportunities.
One factor to keep well in mind when you decide to use annuities to fund your retirement is that you need to do your homework and research, ask as many questions as you can and make sure that you know all of the restrictions and costs before you sign any documents. The reason is that annuities have historically been sold by agents looking to make big commissions and thus they don’t explain the downside as well as they should, as well as the costs and restrictions that you will face.
That being said, annuities are definitely something that should be considered as part of a well-rounded retirement plan. The fact is, Social Security is questionable, the market is volatile and company pension plans are disappearing faster than the dodo bird. With the advice that we’ve given you today (and a bit of research and due diligence), annuities can be the tool that a retiree can use to make sure that their ‘golden years‘ are truly golden..