An annuity is a financial product that delivers what sounds too good to be true: guaranteed income for life. Luckily, annuities are a very real source of retirement income that help ensure you don't outlive your savings.
Currently, more than 50% of near- and current retirees know that their Social Security checks and employer pensions aren't enough to cover their living expenses. Of those, 44% surveyed expressed interest in converting some or all of their savings into an annuity. In fact, 20% of all retirees already use individually purchased annuities as their source of income.
What makes annuities so attractive to so many? Let's start by taking a closer look at traditional sources of retirement funding.
Problems with Traditional Retirement Funding
Many people expect to pay for retirement with a combination of Social Security benefits, a pension, a 401(k), and their personal savings. But these funding sources are nowhere near secure. Pensions are few and far between, since so few employers offer them anymore. Even worse, some public sector pensions are getting slashed as a result of bankruptcies and spending cuts.
Despite its name, Social Security is anything but secure. It currently replaces about 41% of the average worker's income, but this number is expected to drop to 30.5%. To make things worse, the so-called "Great Recession" depleted many people's savings accounts and 401(k)s. What's a near-retiree to do?
Annuities Offer Stability and Tax Advantages
Annuities have two huge advantages over the other types of retirement funding discussed above. Other than pensions, they're the only financial product that provides a guaranteed lifetime income. You also have a great deal of flexibility when deciding how that income comes to you. With a deferred annuity, you can take automatic withdrawals, or choose to take withdrawals only when you need them.
There's also a key tax advantage to owning an annuity. If you buy your annuity with after-tax dollars, you can take advantage of this little-known benefit. The money in that annuity grows at a set rate of interest (it varies by policy and insurer), and it's completely non-taxable until you start taking it out during retirement. You have the chance to grow your money for years, absolutely tax-free, before it starts coming back to you. The Insured Retirement Institute notes that "the tax deferral of annuity earnings is of greater benefit to middle income Americans" than to the wealthy. This is great news! In the past, many people assumed annuities were only meant for the rich. That's certainly not true anymore.
Top Reasons for Buying an Annuity
Because of the stability and tax advantages described above, annuities are a perfect fit for people who want to:
- have a financial cushion in case they live longer than expected
- avoid being a financial burden on a child or spouse
- cover the potentially large expenses associated with long-term care