By Alessandra Malito
Look out for the types of annuities there are, the fees and how payments are structured
With the Federal Reserve's interest-rate hike, annuities may seem like an attractive retirement-income strategy. After all, higher interest rates should mean fatter guaranteed incomes. But there are a few considerations savers must make first.
The central bank raised the federal funds target rate by three-quarters of a percentage point to a range of 1.5% to 1.75% -- the largest hike in nearly 30 years. It also indicated it plans to raise the rate to about 3.4% by the end of this year, and almost 4% by the end of 2023, before expecting to cut rates the following year.
With the news of increased interest rates, as well as skyrocketing inflation and plummeting 401(k) balances, retirement savers may be wondering where to turn to ensure their future retirement security. One option: Annuities, which are insurance products that provide retirees with guaranteed income.
Investors with a focus on retirement may find annuities to be a reprieve from the stock and bond markets that have been crushed as inflation has climbed toward 9%. and inflation stresses, too, since they are intended to provide guaranteed income to retirees when chosen properly.
See:The Decumulation Drawdown: How spending became the big dilemma in retirement
Annuities have had a bad reputation in years past, partially because they are insurance products and there has been distrust in the sales process. Investors also need to understand the fees and stipulations attached to the products they're considering for their own retirement path.
First, know the type of annuity you're buying (or being pitched): fixed-income annuities, which provide a set amount of money on a scheduled basis; variable annuities, which are linked to an investment portfolio; and immediate annuities that are paid for with one lump sum of money.
Also understand how economic factors may impact your retirement income from an annuity. For example, one that offers a fixed payout may not be great when inflation is rising, as purchasing power will be diminished as everyday spending becomes more expensive, said Eric Nelson, a certified financial planner and founder of Independence Wealth.
The Fed's rate hike leads to higher rates for fixed annuities and a higher cap rate for fixed-index annuities, said David Stone, chief executive officer at RetireOne, an insurance and annuity firm that works with financial professionals. (A cap rate is the limit on the growth of an indexed annuity). "In the last 12-15 years, the rates have been so low people have dismissed annuities," he said. "This is the first time in a long time annuities have strong rates."
Working with a financial planner, especially one who acts as a fiduciary and thus in the client's best interest, is crucial, said Byrke Sestok, a certified financial planner and president of Rightirement Wealth.
Because there are so many types of annuities and coming from a variety of providers, the journey to finding the right one can feel overwhelming or complicated. The wrong choice could cost investors money and undue stress.
When choosing an annuity, investors should ask themselves two questions: how much and in what method they want to receive money from these products, such as monthly or annually, and how they plan to fund the annuity.
Some retirees may prefer to put only a portion of their retirement assets into an annuity -- just enough so the payout equates to their fixed monthly expenses. In a scenario like that, retirees may choose to fund "the extras" (an emergency fund, a trip, an unexpected expense or a new hobby) with other income sources, like Social Security or a 401(k) withdrawal.
Also see:Annuities -- do you love them or hate them?
Even when choosing to invest in an annuity, these products should not be treated as the end-all-be-all for retirement income, advisers warn. A stock market downturn may have pushed retirement account balances to uncomfortable lows for some investors, but it "also presents a significant buying opportunity in the months ahead," Sestok said. Investors may have to wait three to seven years for a fixed annuity's investment period, which means available assets that would grow with the market won't be available. "The potential outperformance can be enhanced when money is invested closer to the bottom of the market," Sestok said.
Retirement income planning involves multiple factors, including retirement accounts, pensions if available, annuities, Social Security and any other cash inflow a retiree can expect in their old age. "Annuities are like cereal, they are just part of a healthy portfolio," said Wheeler Pulliam, a certified financial planner and founder of Xponify Financial. "Be wary of positioning them solely as a return-producing investment."
Instead, treat annuities as a way to insure part of your overall retirement income, Pulliam said. And aim to invest no more than 20% to 40% of an overall portfolio into an annuity, he added. "If you follow those principles as opposed to chasing rising rates, then your portfolio will thank you."
(END) Dow Jones Newswires
06-17-22 1558ETCopyright (c) 2022 Dow Jones & Company, Inc.