- Traditional annuities, like income annuities and fixed rate annuities, provide guarantees, and only guarantees
- Market-based annuities, like variable annuities and indexed annuities, are complex products and can’t do everything they promise
- The Personal Pension is a new kind of income annuity that you can build up over time
Early in your working years, it’s common to think about preparing for retirement in terms of assets and accumulation. How much do I need to save? And what kind of return can I make? But, as you get closer and closer to retirement, you realize that what’s important are not assets themselves, but their ability to be converted into income. If you have enough saved, perhaps you can just live off of your portfolio’s interest and dividends. But likely, you’ll also be drawing down your portfolio to pay for your expenses as well. If that’s the case, you risk outliving your savings.
There is another option, and it’s called an annuity. It’s a way to turn your savings into guaranteed income you can’t outlive, no matter what happens in the market or how long you live. When you buy an annuity, you pay an insurance company to take over your market risk and longevity risk. Think about annuities as a way to supplement your Social Security, which likely will cover less than 50% of your spending needs.
We wish it were this simple, and that we could just say that annuities are great. But, that’s not the case, evidenced by the bad rap they get in the media. Like everything else in life, there are the good and the bad. Lucky for us, the distinction between good and market-based annuities is simple: good annuities are fully guaranteed, while market-based annuities are market-linked. We’ll get more into this later, but let’s start with the good.
Annuities Overview: Traditional Annuities
The traditional types of annuities are fixed annuities and income annuities. Fixed annuities are like CDs. They help you grow your assets at a guaranteed return for a short period of time. They’re useful, but not the most important type of annuity out there.
The type of annuity you should care about most is called an income annuity. It’s the original and most basic annuity out there. (Actually, in other countries, if you just use the word annuity, it refers to the income annuity. But in the U.S., the evolution of the product into various types of annuities requires us to add the ‘income’ descriptor.)
An income annuity, very simply, provides a guaranteed, steady source of income that continues for life. When you deposit money into an income annuity, whether in the form of one lump sum or gradually over time, you permanently convert assets into income. Why? Because you can run out of assets, but you cannot run out of annuity income. In this way, income annuities are the opposite of life insurance. Life insurance protects your family if you pass away prematurely. Income annuities protect you if you end up living longer than you expect.
There are three types of income annuities: immediate annuities, longevity annuities, and Qualified Longevity Annuity Contracts (a type of longevity annuity). They differ in (1) when income starts, and (2) where the money to fund the annuity comes from. With immediate annuities, income starts, well, immediately. These annuities are purchased by people about to retire or already in retirement. With longevity annuities, income starts 2-40 years from now, thus purchased by people years away from retirement. For both of these, you can use pre-tax IRA money or post-tax savings to fund them. But, the QLAC is a special type of longevity annuity that only accepts IRA money and has income starting between ages 70 1/2 and 85. They are typically purchased by people looking to defer their RMDs.
While we’re on the topic of income annuities, we should mention the Personal Pension. It’s a first of its kind retirement product that leverages the income annuity concept but makes it even easier to get started. Unlike an income annuity where you pay in all at once, you make contributions to the Personal Pension with as little as $100 a month throughout your working years, with each contribution locking in a portion of your desired future income. The Personal Pension makes the most sense as a complement to your market-based 401(k) or IRA savings, giving you access to a guarantee you can’t outlive like the others can’t.
Annuities Overview: Market-Based Annuities
Now for the market-based annuities: variable and indexed annuities. Very simply, these products over-promise and under-deliver. They claim to provide (1) guaranteed income, (2) access to market upside, (3) protection against losing money, and (4) liquidity. Just like 2-in-1 shampoo-conditioner, they wind up not doing any of these things well. So why do they even exist? Well, income annuities can be hard to sell because they don’t offer liquidity. That means your money is permanently converted to income and can’t be accessed in any other way. Agents and brokers wanted something easier to sell, so the insurance companies modified the existing products, adding bells and whistles that, in our opinion, wound up just eroding the real value of the product.
But, the real answer to the question about which type of annuity is better is in the commission. This is what insurance companies pay agents and brokers to sell annuities. Commissions for variable and indexed annuities are significantly higher than for income and fixed rate annuities. Because there’s somewhat of a zero-sum relationship among the insurance company, the client, and the agent/broker, it’s clear that a higher commission for the agent/broker means less value for you.
To sum up, traditional annuities (income annuities and fixed rate annuities) are fully-guaranteed products. On the day you put money in, you know exactly what you’re getting out. Market-based annuities (variable annuities and indexed annuities) are not fully-guaranteed. They’re market-linked, meaning that what you get out depends on what happens in the market and how the product is structured. With market-based annuities, the insurer is acting as both as an investor and an insurer, when the latter is really the only thing you want them doing for you.
How Can I Purchase an Annuity?
At Blueprint Income, we offer annuities from more than 30 top rated insurance companies, including Guardian Life. Click below to get real-time personalized income annuity quotes and/or see the entire market of fixed annuities.
From there, you’ll get access to our annuity guides and team of specialists to help you analyze your retirement finances and walk you through the application process.
How Can I Start a Personal Pension?
A Personal Pension is a contract between you and top rated insurance companies. By making contributions to your Personal Pension over time, you develop a portfolio of guaranteed income available in retirement. Blueprint Income offers a Personal Pension account with the lowest minimum, $100. After opening an account, you can continue to contribute flexibly in $100+ increments. Each contribution which will increase your pension check. Click below to customize a Personal Pension for you.