But annuities are only one part of retirement insurance. A complete retirement protection plan includes other elements. Understanding the role of each element is key to purchasing correctly.
Before considering any retirement insurance product, maximize your other retirement income sources first. Social Security benefits are the foundation of most Americans’ retirement income. You can start at age sixty two, but for each year you delay, your monthly benefit increases by about eight percent. If you delay until age seventy, your monthly benefit is about seventy six percent higher than if you had started at sixty two. This is the best “insurance” you can get: guaranteed for life, adjusted for inflation, and with no fees.
Employer retirement plans are another foundation. If your employer offers a matching contribution, you should contribute at least enough to get the full match. The match is a one hundred percent return, unmatched by any investment.
After using these free sources of money, you can consider commercial retirement insurance products.
When purchasing an annuity, you need to make several key decisions. The first is choosing between an immediate annuity and a deferred annuity. With an immediate annuity, you pay a lump sum and start receiving income soon after. This is suitable for people already retired or about to retire. With a deferred annuity, you pay now but do not start receiving income for years or even decades. This is suitable for people still working who want their money to grow tax-deferred.
The second decision is choosing between a fixed annuity and a variable annuity. A fixed annuity guarantees a minimum interest rate and a fixed income amount. It is safe and predictable, but returns are lower. A variable annuity’s returns are tied to market performance. When markets do well, income is higher. When markets do poorly, income is lower. You take the investment risk, but you have the potential for higher returns. For most people, a fixed annuity or a fixed-indexed annuity is more appropriate. Variable annuities have higher fees and more complex structures.
The third decision is whether to choose a guaranteed period. A guaranteed period means that if you die soon after starting to receive income, the insurance company continues to pay your beneficiaries for a certain number of years. Without a guaranteed period, payments stop when you die. A guaranteed period lowers risk but also lowers your monthly income amount.
The fourth decision is whether to choose inflation protection. A regular annuity’s income amount is fixed. Twenty years from now, that same amount will buy only half of what it buys today. Inflation protection increases your income as prices rise. But inflation protection is expensive and significantly reduces your initial income amount. Many people choose not to buy inflation protection and instead use other assets to hedge against inflation.
Before purchasing an annuity, ask yourself several questions. Do you have sufficient other retirement assets? An annuity should be part of your retirement income, not all of it. What is your health status? If you have a chronic illness or a shorter life expectancy, an annuity may not be a good choice. Do you understand all the fees? Annuity fees include mortality and expense charges, administrative fees, and rider fees. These fees affect your ultimate income.
Beyond annuities, there are other retirement insurance products. Long-term care insurance is an important part of retirement protection. Many people need long-term care in retirement, but Medicare and supplemental insurance cover only a small portion. Long-term care insurance helps pay for nursing homes, assisted living, or in-home care. The best time to buy is between age fifty five and sixty five. Buy too late and premiums are too high. Buy too early and you may pay for many years before needing it.
Finally, retirement insurance is not a buy-once-and-forget product. Your health changes. Markets change. Tax laws change. Your needs change. Review your retirement plan once a year. Make sure it still fits your situation. If adjustments are needed, do not hesitate.
The key to properly purchasing retirement insurance is this: do not buy products you do not understand. Do not make on-the-spot decisions due to sales pressure. Do not put all your eggs in one basket. Combine multiple income sources: Social Security, employer plans, annuities, personal savings, and perhaps long-term care insurance. Diversification is not only an investing principle. It is also a retirement protection principle.
