The biggest stress for retirees is the fear that they’ll outlive their money. And this fear isn’t unwarranted.
Unfortunately, it’s all too common for individuals to overspend their lump sum retirement fund too early, leaving them with nothing in later years of their long and healthy life.
That’s where an annuity comes in. Drawing income from an annuity is the best way to ensure that you have a consistent flow of money for the rest of your life… no matter how long you live.
What’s An Annuity?
An annuity is a contract sold by an insurance company. That’s right—annuities are a form of insurance. You are insuring your livelihood against the possibility of living longer than you might anticipate.
How it works: You pay the insurance company either a lump sum or multiple payments equating to the total cost of an annuity. If you have a deferred annuity (which we’ll go over below), you can continue to add money to your annuity “stash” until annuitization.
Annuitization is when you begin drawing income from an annuity. Basically, this is when you start getting your paycheck from the insurance company that holds your annuity.
You, the annuitant, will then receive regular payments for the rest of your life, ensuring you always have money to live on. (Note that some annuities allow you to receive payments for a specific period of time, like 10 or 15 years, rather than a lifelong annuity income stream.) The amount you receive each month when drawing income from an annuity is called the withdraw rate.
What Are The Benefits Of An Annuity?
Do you want to be happy and carefree in your retirement? Then an annuity may be the right retirement solution for you. Research has proven time and time again that retirees drawing income from an annuity tend to be happier and more satisfied than their counterparts with other forms of retirement savings.
This is likely because annuity-retirees have a greater sense of security and comfort for their future, knowing they will continue to receive an income indefinitely.
Below are three studies that prove the happiness benefits of an annuity:
- The 2012 Towers Watson report “Annuities and Retirement Happiness” found that retirees that received a guaranteed income, like an annuity, had higher retirement satisfaction scores than their counterparts.
- A 2003 Rand study “Annuities and Retirement Satisfaction” also reported that retirees with annuities had higher levels of well-being. They also maintained that satisfaction for a longer period during retirement.
- The TIAA-CREF Institute Survey found retirees that converted at least part of their savings into annuity payments were 60% more likely to report a higher standard of living in retirement.
Drawing income from an annuity makes retirees secure and happy. Happy people tend to be healthier and live longer. And with an annuity, you can live that long, happy life and still get paid your income each month!
Basically, drawing income from an annuity offsets longevity risks with a guaranteed stream of cash flow. Nevertheless, some deferred annuities can still offer some risk for the betting retiree who wants to play the investment field a bit more.
Other advantages of annuities include tax deferral and unlimited contributions. Tax deferral means that taxes aren’t taken out until you begin drawing income from an annuity. This could be beneficial for anyone who is in a higher tax bracket now and expects to be in a lower tax bracket during retirement.
Moreover, unlimited contributions means that you can put in as much cash as you want towards your deferred annuity investment… without paying taxes. This is a great option for people who are nearing retirement and have to “catch up” on their savings.
What Are The Types Of Annuities?
Below, we’ll discuss the basic types of annuities, especially with regards to drawing income from an annuity. We’ll go through how income is activated depending on the annuity type, as well as the reasons and benefits for buying that specific kind of annuity.
First, you need to consider when your annuity income should begin. This helps you determine whether you will have an immediate or deferred annuity. There are then four key types of deferred annuities: fixed, variable, indexed, and QLAC.
You should then decide how long your income should last, whether for life or a set number of years.
Then, you’ll want to decide whether you want the highest guaranteed payout or a guaranteed payout for you and your spouse/heirs.
With an immediate annuity, you pay a lump sum to buy the annuity, and your payments begin right away. This means that the annuitization is effective immediately.
An immediate annuity can be for a set number of years or for life. Generally, a set number of years will have higher monthly payouts than the for-life option.
However, most people will not consider an immediate annuity for a set number of years, because they would then still have the risk of outliving their payments.
Some people will purchase an immediate annuity alongside other deferred annuities as a means of “laddering” their payouts (when the first annuity’s set of years runs its course, the second can kick in.)
The insurance company determines the payment based on the current level of interest rates and the age you begin receiving payments.
Higher interest rates equals higher payment; and the older you are, the higher your payment. The rate remains level and unchanging until death.
For example, your insurance company might say, “You will be drawing income from your annuity in the amount of $5,000 every month for the rest of your life. “
Who It Benefits:
Immediate annuities are best for people who want to maximize their personal annual income for the rest of their lives. Usually, these individuals don’t have family members who will be dependent upon their income upon their death.
Immediate annuities usually cannot be passed on to heirs. However, there is an optional joint-and-survivor rider that allows a specified spouse or partner to continue receiving payments for a set period of time after you die.
You cannot withdraw money from an immediate annuity. This means that you can’t dip into the investment fund to pay for emergencies or unexpected expenses. In this way, it’s generally recommended to keep a separate savings account with emergency funds alongside an immediate annuity.
Additionally, immediate annuities always remain constant. You will receive the same amount every month, even if your investment itself is rolling in dough. You will receive no more and no less than your guaranteed withdraw rate.
However, there is an optional inflation rider, which decreases your income for the first several years and increases it in later years, as a way to offset potential economic inflation.
With a deferred or longevity annuity, you will start drawing income from an annuity at some point down the road. You will pay a lump sum at the beginning to purchase the annuity, but annuity income payments will not start yet.
Before annuitization, you can continue to add money to your annuity to grow your investment. Once annuitization begins down the line, you start drawing income from an annuity in the same way as you would with an immediate annuity.
The idea is that you’ll start getting income later in retirement while allowing you to put up less money upfront to purchase an annuity.
These funds are also tax-deferred, and there is no required minimum distribution (unless you invest your IRA dollars in the annuity). Learn more about Taking RMDS With An Annuity here.
Length: You can choose to receive payments for a set number of years or the rest of your life. For deferred plans, you are able to begin drawing income from an annuity without penalty after age 59 1/2.
Withdraw Rate: The withdraw rate and payout potentials will be dependent upon the type of deferred annuity, which will be discussed further below.
Who It Benefits: Generally, a deferred annuity is good for people who –
- are still working and want to continue to add to their investment.
- have other income in beginning of their retirement and want to save their annuity income payments for later in life.
- want to ensure that their spouse or heirs also receive payouts.
Note that fixed, variable, and index annuities allow for joint riders. This puts two names—generally spouses or partners—on the same annuity. The annual payout tends to be lower, but the surviving partner will continue drawing income from an annuity after one partner dies.
Deferred Annuity – Fixed
Think of a fixed annuity as similar to a savings account. Your annuity money is invested into long-term bonds and builds interest for a set period of time.
Withdraw Rate: Each year, you can receive annual withdrawals in the form of your interest on that investment. This is usually up to 10% of the value of the annuity.
There is no penalty for interest withdrawal, unless you are younger than the age 59 1/2. Down the road, annuitization will convert the fixed annuity investment into a guaranteed income stream.
Who It Benefits: This is good for the non-risky person who wants to continue drawing income from an annuity at a fixed, unwavering level for the rest of his or her life.
It is also good for someone who wants to leave a legacy; if you die while owning a fixed annuity, your annuity “pot” (including the interest you’ve earned) will go to your beneficiaries.
Deferred Annuity – Variable & Index
Withdraw Rate: When drawing income from an annuity that is variable or indexed, you will always receive a minimum income.
The minimum is usually 1% of your investment per year on average. This ensures you have some sort of income stream each year.
However, your variable/index paycheck can increase depending on the performance of the investment. The future income is variable based on the success of the investment.
This means you might be drawing income from an annuity with abundant wealth one year, and another year you could have a low minimum income.
Who It Benefits: A variable or index deferred annuity is made for the retiree who wants to task some risks without betting away their livelihood. You are still guaranteed money for life, but you have the ability to further grow your investment.
There are also a number of riders, including joint/spouse and death riders, that guarantee a future payout for family members upon death. This can leave your family with high-performing investments after your death.
Deferred Annuity – QLAC
A new form of deferred annuity, the QLAC, allows you to invest a lump sum up to $125,000 or 25% of your retirement account balance. That lump sum then guarantees you a future income as with other annuities. However, it’s slightly different than other types of annuities.
Withdraw Rate:When drawing income from an annuity with a QLAC plan, you generally have a fixed rate per month that is based on: interest rates, age at purchasing, and number of years on the limit.
Because it never goes to beneficiaries and is generally for a set number of years, the QLAC allows for insurance companies to pay out each individual slightly more money.
Who It Benefits: A QLAC is for the retiree who wants a higher payout for a shortened period of time, like 10-15 years. It’s best for those looking for a single-life income, as it cannot go to beneficiaries and is not eligible for joint riders.
When To Start Drawing Income From An Annuity
If you are not purchasing an immediate annuity, you need to think carefully about when you’d like to begin drawing income from an annuity.
You should talk to an advisor to discuss your annuity timeline based on your age, current interest rates, and your future plans for retirement.
This is especially important as some deferred annuity products will expire. This means that if you don’t start drawing income from an annuity within a certain time period, you can actually lose out entirely.
You may need to renew your move your annuity contract. You also may be forced to take withdrawals on annuities if you’ve reached age 70 1/2 and haven’t yet started paying taxes on your retirement savings.
The Bottom Line
When you purchase an annuity, you’re buying insurance for the possibility of living a long and healthy life… which is what we hope for you! An annuity is one of the best options to ensure you have a guaranteed stream of income every year, no matter how long you live.
But we understand that annuities are complex and confusing. It’s important to understand how and when drawing income from an annuity will affect your retirement savings and lifestyle.
We invite you to “draw” on Sunpath’s expertise about drawing income from an annuity. Contact us now to start discussing the guarantee of your future.