A way to guarantee you never run out of money

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Imagine if you had your own personal pension, guaranteed to send you a check every single month for the rest of your life (starting in your 60s or later). Would that help you sleep better at night? Ironically, such a product does exist, but it doesn’t get much love. I’m talking about annuities. Annuities suffer a bad rap due to claims that they’re rip-offs (charging high fees for mediocre investments) and horror stories of unscrupulous agents selling them to folks (especially seniors) who don’t understand what they’re getting into. I’m not going to defend agents who put making a quick buck ahead of making sure their customers get something that will serve them well and that they have realistic expectations about. But I also don’t want misinformation to get in the way of people who could benefit from a quality annuity that’s been properly tailored to their situation. Consider these facts: our life expectancies are on the rise, yet most Americans no longer have access to a pension, and Social Security isn’t sustainable the way it is now. (In fact, changes have already been made in an effort to keep the program alive. For example, the age when you could claim “full retirement benefits” from Social Security used to be 65, but now, for everyone who was born in 1960 or later, that age is 67.) If you find any of that troubling, don’t hate on annuities. They may be just the lifeline that many Americans are looking for.

Another advantage of annuities that goes largely unrecognized is how they can help you cope with RMDs, the withdrawals from your pretax accounts that the tax code requires you to make starting at age 70½. In a previous post, I explained that the government’s timetable for RMDs forces you to withdraw an ever-increasing percentage of your pretax accounts, which makes it difficult if not impossible to rely on those accounts for lifetime income (even though those accounts are supposedly for your retirement). Well, if you or someone you know find that you’ve inadvertently boxed yourself into a corner by accumulating the bulk of your retirement assets in pretax accounts, then an annuity can offer some relief. Depending on the specifics of the annuity and how you choose to set up the monthly checks, this relief will come in one of two forms. In the first, you’re exempted from the vicious circle of taking an ever-increasing chunk out of an ever-shrinking pool of money; your monthly checks will still be taxable, but the amount of each check can stay the same year after year. In the alternative form of relief, the amount of your monthly checks gets bumped up as needed to satisfy your RMDs, and if that ends up depleting your account, the insurance company will continue sending you monthly checks anyway for the rest of your life. It’s also worth mentioning here that there’s a special type of annuity called a QLAC (qualifying longevity annuity contract) that lets you take a portion of your pretax money and hold off on taking any withdrawals from it until you turn 85.

Now, to address some of the common concerns regarding annuities. One is that annuities impose higher expenses than just investing in ETFs (for example), and that the returns are subpar. If your goal is simply to invest money and have it grow in value, then annuities certainly are hampered by expenses and a relative lack of investment freedom. (Some annuities don’t charge you anything, but the tradeoff is that you’re limited in terms of how much interest you can earn. Still, such an annuity might be a better deal for you than parking money in a CD (certificate of deposit) at a bank.) But if you’re seeking a hedge against the risk of running out of money later in life, then annuities provide a value that no other investment does. Not even bonds. Bonds don’t keep paying out indefinitely; you continually have to buy new ones, and each time you do, you face the possibility that you won’t be able to get as favorable terms on the new bond as you had on the one that just expired. And if you hold bonds in a pretax account, you need to manage the cash flow to accommodate your RMDs. Otherwise, you might wind up having to sell a bond for less than you paid for it, just to raise cash to pull out of the account so that it can be taxed! So, if you’re considering an annuity as insurance against outliving your money, rather than as an investment, then that is the basis you should use to evaluate the annuity’s expenses. Another concern I’ve heard voiced about annuities is that they’re hard to understand, making it easy for an unscrupulous agent to pull the wool over your eyes. Well, the truth is...annuities are complex instruments. They’re like a machine with lots of moving parts. But you know what? So are automobiles. You don’t need a thorough understanding of how all the moving parts of an annuity work together in order to make an informed decision as to whether a particular annuity is a good fit for you or not. In my next post, I’ll endeavor to equip you with the tools you need to make informed decisions about annuities.