Annuity options explained

Investment or income stream? Here are tips on how to think through annuity options.

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Akweli Parker: This one comes from Catherine in Bethesda, Maryland, and she wants to know when and for whom are annuities a good idea? Now, Stephen, we talked about this a little bit, so why don’t you take this one.

Stephen Weber: Getting back again to what Danielle was saying, you’ve really got to think about annuity as two different kinds of things. There’s the annuity that’s an investment and an annuity that’s an income stream. There’s a few instances where if you’re really looking for tax deferral and you’ve used up your 401(k) and your IRA and the other vehicles that you might use to get tax deferral and you’re a high income type earner, an annuity may be appropriate as an investment in that situation or maybe not.

When you talk about as an income stream, however, there really is a lot more general applicability. Almost everyone who saves for retirement, one of the reasons that they’re saving for retirement is to get income. So one of the most efficient ways to get income from a portfolio is to purchase an income annuity. So if you ask yourself the question if I really needed to, I could live on as little as, fill in the blank number, right? And you could ask yourself, “Well, do I have the income that gets me at least that far?” Through my Social Security, through pensions that I have through my employer, any other types of guaranteed income sources. If your answer to that question is yes, then there’s a good chance you don’t even, that you wouldn’t need or really even consider an income annuity. But if the answer to that question is no, you have money that you’re going to need to spend anyway, and an income annuity might be a good way to do that. And I’m sure as we go through this webcast, we’ll get more into the reasons why it might or might not be appropriate.

Akweli Parker: Absolutely. Okay, we do have another live question. This one is from Richard, and Richard asks, “How do annuities differ from a person managing their own portfolio and setting up monthly withdrawals?” So I mean what is the real advantage to going this route?

Stephen Weber: So, that’s a great question. It’s really the heart of deciding whether or not an income annuity is for you. And even if you do choose an income annuity, there probably will be some use of both withdrawing down from a portfolio and using an annuity.

But the basic difference is how you feel about the need for guaranteed income. So if you think about what I said before about sort of that basic level of what you’re going to spend anyway, you can draw down from a portfolio and use whatever portfolio drawdown rate you need. And you’re probably fine, and you probably won’t run out of money. Well, not for whatever rate, but a good withdrawal strategy can help you in that regard.

But life conditions can happen. You could end up in a long-term care situation. The market could go the wrong way. There’s a lot of things that could happen that if you just want to make sure that you have sort of a basic income that lasts for life, you may want to pull back on that a little bit with a portion of your portfolio that you know you’re going to spend anyway because again, this is the basic amount of money that you think you need to live. Right, so it’s going to have to come out of your portfolio. It’s not like you have the choice to spend it or not to spend it.

So some people would like to guarantee sort of a floor for the amount of money that they have so that they’re secure in the knowledge that if anything were to go wrong, they would always have at least that basic amount of income.

Now some people, on the other side, right, you’re going to say, “Well, I don’t need that because I’m a good money manager and I’m only going to need to withdraw 2% of my portfolio in order to get sort of a basic level of income and things like that.” And that’s fine. You know, it’s not for everybody. It is for some people though, and really the basic difference is do you really feel like you need a guarantee? And the place that most people are going to feel like they need a guarantee is for this sort of minimum income level that they want to have to survive so that they just don’t have to worry about it. And if the market crashes, at least they don’t need to worry that their basic income is going to be in jeopardy as a result.

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