You have worked hard and invested and saved diligently for years. However, that does not change the fact that you are still worried about market losses and may need more time to recover. Without a doubt, one of the biggest fears in retirement is outliving your savings.
So how do you conquer the fear of running out of money? To put it short and sweet- you should create an income that lasts, and that is guaranteed.
In this article, we will take a deep dive into guaranteed retirement income annuities. They are one of the most conservative strategies out there. Yet, they offer peace of mind with a reliable, lifelong income stream. We will be sure to cover what they are, how they work, their advantages and disadvantages, and how you can set up your guaranteed retirement income.
Turning Retirement Savings Into Guaranteed Retirement Income
For a long time, pensions guaranteed a lifelong retirement income. In addition, they created a reliable cash flow that recipients could rely on to fund the entire duration of their post-working years.
But in today’s world, pension plans are becoming increasingly rare. So instead, most retirees will have to create a retirement income plan. And if they’re looking to develop a system with regularly scheduled payments, they may pay attention to annuities.
Annuities are contracts provided by insurance companies that investors can use to create an income stream throughout their lifetime. However, not all annuities offer the same security benefits as a traditional pension plan.
Instead, if you want to mimic the structure of a pension, you will need to look at guaranteed income annuities. Their fixed nature will enable you to create a predictable income stream for your retirement and life.
What Is A Guaranteed Retirement Income Annuity?
Guaranteed retirement income annuities are contracts with insurance companies that provide you with consistent, fixed payments. Through their structure, you can convert your retirement savings into reliable monthly payments for life.
There are five different types of annuities. Four of the five types of annuities offer guaranteed income options.
Regardless of the type, you choose your annuity payout depending on several factors. For example, you can fund your annuity with a lump sum or monthly premiums.
Fixed Lifelong Annuities
With fixed lifelong annuities, you can receive a guaranteed income for life. Your income is “fixed” because it is provided at the same level regardless of market performance. And there are protections for beneficiaries, and you can add a cost of living adjustment rider (COLA).
Payments out of your fixed lifelong annuity can begin immediately, or at a date you specify in the future (deferred).
Fixed Annuity (with a Guaranteed Lifetime Withdrawal Benefit, or GLWB)
You will have additional flexibility if you choose a fixed deferred annuity with a GLWB. Of course, you will still have an income guaranteed for life. But you will have more choices should your circumstances change.
With this option, you can access a portion of your annuity’s accumulated value if you need some (or all) of your money earlier than expected.
Who’s Guaranteeing The Income Annuity?
Remember, your annuity is created through an insurance company, and they can back your annuity’s guarantee of a lifetime income. On top of that, by having an insurance company in your corner, you can overcome some of the biggest worries in creating a sustainable retirement:
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- Outliving Savings: You will be okay with your savings lasting long enough. The insurance company is the one that must keep the payments lasting for life.
- Market Volatility: Whether the stock market is skyrocketing or dropping like a rock, the insurance company is contractually obligated to pay your annuity’s income stream.
- Inflation Rates: You can add a cost-of-living feature to your guaranteed retirement income annuity. This helps protect your income stream’s purchasing power over time.
Will An Income Annuity Cover My Spouse And Me?
A guaranteed retirement income annuity can cover both you and your spouse.
One way to approach coverage is to consider joint and survivor annuities. These annuities are signed jointly by you and your partner. They are made explicitly for retired couples who want a guaranteed monthly income stream for their lives.
However, even if you do not enter a joint contract, you can still set up your lifelong annuity to protect your spouse (and even children, for that matter). That is because you can add specific beneficiary features that will payout by your annuity’s structure.
How Are Payments Structured With Guaranteed Income Annuities?
How your annuity’s lifetime income reaches you (and your beneficiaries) will depend on the type of annuity payment structure you select. Some of the most common annuity payment structures include:
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- Life Only: This option offers the highest payments. That’s because they only last for the duration of your life. Nothing goes to inheritors because there are no protections for beneficiaries.
- Life With A Refund: This option allows for a refund if you pass away before your annuity pays out the total of your initial investment. The balance of your annuity will go to your designated beneficiaries.
- Life With A Guarantee Period: This option continues payments to beneficiaries should you pass away before your guarantee period ends. Your guarantee period is the minimum years your insurance company agrees to provide your annuity income.
- Guaranteed Income Rider: By electing a guaranteed income rider, you and your spouse can receive a guaranteed income for life without annuitize your contract.
What Are The Benefits Of A Guaranteed Income Annuity?
1. More Security In Retirement: This is the primary benefit sought after with guaranteed income annuities. They provide a lifetime income stream that eliminates the fear of losing your retirement money.
2. Predictable Planning Income: You’ll be to set a schedule for payouts with your guaranteed income annuity. This allows for far more certainty when planning your retirement income streams.
3. Anti-Inflation Protection: A guaranteed income annuity can have an added cost-of-living feature. This helps protect your predictable income stream from the devaluations of inflation.
4. Investment Diversification: By having assets in a guaranteed retirement income annuity, you diversify your retirement income by proxy.
Are Their Drawbacks of a Guaranteed Income Annuity?
All investments have risk and opportunity costs. However, only you can determine how much risk you are willing to take.
1. Opportunity Cost: Risk and Return are related. With a guaranteed income annuity, you can receive a competitive return. However, if you invested your money in a stock portfolio, you may receive a higher return. Still, you are subjected to market risk and the possibility of running out of money due to the sequence of return risks. Therefore, retirees must be careful and take only a slight risk in an income portfolio.
2. High Surrender Charges: With the safety of guaranteed income, your annuity may have a surrender charge. However, the surrender fee is only applied if you withdraw all your money. Therefore, the surrender charge will not affect your guaranteed income.
3. Lack Of Inflation Protection: Inflation can eat your payments. If you do not add a COLA rider to your guaranteed income annuity, your annuity income will not increase.
4. High Fees: We have all heard that annuities have high fees. However, three out of the five types of annuities do not have fees. Some financial advisors who are not licensed to sell annuities use this high-fee sales tactic—implying that their advice is free or less than the annuity fees. All investments charge fees. As an investor, you should look at the fees, make an educated choice, and not rely on a blanket statement.
How Is A Guaranteed Income Annuity Taxed?
You can fund an annuity with qualified and non-qualified funds. Both qualified and non-qualified annuities will grow tax-deferred. But once you start collecting payments, you’ll start paying taxes on everything as ordinary income.
Taxes On Qualified Annuities
If your annuity is funded with pre-tax dollars, say with money from a 401(k) or traditional IRA, it is classified as a qualified annuity.
When you start receiving payments from your qualified annuity, your income is fully taxable. This would be the same tax treatment if you left your 401k or IRA in any other type of account.
Taxes On Non-Qualified Annuities
A non-qualified annuity is an annuity that is funded with after-tax dollars. Your original investment cost basis is not subject to any tax. Only the growth is taxable when you take it out of your annuity. It will grow tax-deferred if you do not receive any money from an annuity.
Suppose you have a non-qualified annuity and are receiving income from turning on an income rider. The amount of taxes you owe on your non-qualified annuity is determined by an exclusion ratio. This ratio determines what percent of your income is taxable and what percent is not. In addition, it considers the principal amount used to buy the annuity, how long it has been active, interest earned, and the annuitant’s (i.e., you) life expectancy.
The principal amount, after-tax dollars, is spread across the remaining life expectancy of the annuitant and is exempt from taxes. Any income that exceeds this principal amount, however, is earnings.
What Else Should I Know About Guaranteed Income Annuities?
1. Early Withdrawal Penalties: Similar to other retirement accounts (IRAs), any withdrawals made before age 59 ½ will be imposed a 10% due to IRA tax rules.
2. State Regulation: Each state’s insurance commissioner approves each annuity for their state.
3. No FDIC Backing: The Federal Deposit Insurance Company (FDIC) only is for banks. Having your annuity backed by an insurance company has its advantages. But what if the insurance company goes bankrupt? Your state’s insurance fund only further insures the value of your annuity. These funds will reimburse you for the value of your annuity up to the statutory limit. But that limit can range from $250,000 to $1 million, depending on your state.
How Do You Set Up A Guaranteed Income Annuity?
Step 1 Find A Reputable Provider: You must select a reliable insurance company to service your annuity. You can look up ratings for various providers through Moody’s and Standard and Poor’s systems.
Step 2 Fill Out An Application: Once you’ve identified an insurance provider, request an application for your annuity. Please fill it out thoroughly, submit it, and wait for the approval.
Step 3 Fund Your Annuity: Once approved, you can start putting money inside your annuity. You can fund with cash or rollover funds from a retirement or investment account. But remember, how you fund your annuity will have important implications come tax time!
Step 4 Monitor Your Annuity: Make sure you have easy access to your annuity’s information. Usually, this is an online profile with your insurance company. You can track your progress, request a withdrawal, and update your beneficiaries.
How Can Vertical Wealth Management Help?
At Vertical Wealth Management, we help our clients with one of their biggest fears – running out of money in retirement. And one of the ways we do this is by exploring options that convert their nest egg into an income stream that lasts.
Guaranteed income annuities appeal to retirees, given their ability to provide a predictable income for life. They’re resistant to market volatility and can, through a rider, counter the effects of inflation. Additionally, your beneficiaries will receive any money left in your annuity contract.
Together we can partner with you to evaluate your unique retirement needs. And as a team, we’ll be able to determine the best course of action in building a retirement income that lasts. To learn more about fixed annuities and other income stream options, please feel free to schedule your complimentary consultation.