Building Your Own Pension: How Annuities Can Help Create Retirement Income
Building Your Own Pension: How Annuities Can Help Create Retirement Income
For generations, pensions provided retirees with a predictable paycheck for life. Today, fewer workers have access to traditional pensions, which has led many people to consider annuities for retirement income as one way to create a dependable income stream in retirement.
Today, traditional pensions are much less common, leaving many retirees responsible for turning their own savings into reliable retirement income.
That’s where an annuity may be useful.
Certain annuities can convert a portion of your retirement savings into a predictable stream of income—including income that can be guaranteed for life. In that sense, an annuity can help you create something that looks a lot like your own personal pension.
Why Consider an Annuity for Retirement Income?
Predictable Income
One of the biggest challenges in retirement is figuring out how much you can safely spend.
Investment accounts fluctuate with the market, and withdrawing too much during a downturn can put additional pressure on a retirement portfolio.
An annuity with an income guarantee can provide a predictable payment regardless of day-to-day market movements. Depending on the type of annuity and options selected, those payments may continue for a specified period or for the rest of your life.
That can make budgeting for recurring expenses in retirement considerably easier.
Protection Against Outliving Your Income
No one knows exactly how long retirement will last.
A longer life is something to celebrate, but it also creates a financial challenge: your retirement assets may need to support you for 20, 30 or even more years.
Certain annuities can provide guaranteed lifetime income, helping address what is often called longevity risk—the risk of outliving the assets you’ve accumulated for retirement.
The guarantees of an annuity are subject to the claims-paying ability of the issuing insurance company.
Tax-Deferred Growth
Another feature of annuities is tax deferral.
With a non-qualified annuity, you generally don’t pay income tax on growth inside the contract as it occurs. Instead, taxes are generally due when taxable gains are withdrawn.
Withdrawals of taxable amounts are generally subject to ordinary income tax, and withdrawals made before age 59½ may also be subject to a 10% federal additional tax, subject to applicable exceptions.
An annuity purchased within an IRA or another tax-qualified retirement account does not provide additional tax deferral beyond what the retirement account already provides.
Different Annuities for Different Retirement Needs
“Annuity” describes a broad category of insurance products rather than one specific strategy. Different types of annuities are designed to accomplish different things.
Immediate Annuities
With a single-premium immediate annuity, you generally give an insurance company a lump sum in exchange for an income stream that begins relatively soon.
You may be able to structure payments for a set number of years, for your lifetime, or for the joint lifetimes of you and your spouse.
This can be one of the more direct ways of turning a portion of accumulated savings into pension-like income.
Deferred Annuities
A deferred annuity allows money to accumulate before income begins.
Depending on the contract, growth may be based on a declared fixed interest rate, the performance of an underlying investment portfolio, or changes in a market index subject to the terms and limitations of the contract.
Fixed Annuities and MYGAs
A Multi-Year Guaranteed Annuity (MYGA) is a type of fixed annuity that provides a guaranteed interest rate for a specified period, such as three, five or seven years.
MYGAs can be useful for people who want predictable accumulation without direct exposure to stock-market losses.
They are sometimes compared with certificates of deposit because both can provide a stated rate for a defined period. However, they are very different financial products. CDs are bank products and may qualify for FDIC insurance within applicable limits. Annuities are insurance contracts, are not FDIC insured, and their guarantees depend upon the claims-paying ability of the issuing insurer.
Annuities can also have surrender charges and different tax treatment, so the interest rate alone shouldn’t determine which is appropriate.
Creating a “Personal Pension”
For many retirees, the objective isn’t necessarily to put all of their savings into an annuity.
Instead, an annuity can potentially be used to cover a portion of essential monthly expenses.
For example, imagine a retired household has recurring expenses for housing, utilities, groceries, insurance and healthcare. Social Security may cover part of those expenses.
An annuity could potentially be used to create another predictable income stream to help cover the remaining gap.
Other assets can then remain available for discretionary spending, emergencies, legacy goals or continued investment.
The result can resemble the retirement structure previous generations received from traditional pensions—but created using your own retirement assets.
What About Your Spouse?
Retirement income planning often needs to account for two lives rather than one.
Many annuities offer joint-life income options, which can continue payments for as long as either spouse is living.
Other contract options may provide death benefits or guarantees for a minimum payment period.
These choices matter. Adding guarantees or survivor provisions can affect the amount of income the contract provides, which is why it’s important to understand the tradeoffs before selecting an income option.
Are There Downsides to Annuities?
Yes. Annuities aren’t appropriate for everyone, and the details matter.
Depending on the product, considerations can include:
- Liquidity: Some annuities impose surrender charges for withdrawals above permitted amounts during the surrender period.
- Inflation: A fixed payment may lose purchasing power over a long retirement unless the contract provides some form of increasing income.
- Growth potential: Products emphasizing guarantees may offer less upside than investments that accept greater market risk.
- Fees and complexity: Some annuity contracts are relatively straightforward, while others include optional riders, investment expenses and additional fees.
- Insurer strength: Annuity guarantees are based on the financial strength and claims-paying ability of the insurance company issuing the contract.
That’s one reason comparing contracts from multiple insurers can be valuable.
Is an Annuity Right for You?
There isn’t one answer for everyone.
An annuity may be worth considering if you’re approaching or already in retirement and place a high value on predictable income, principal protection, tax-deferred accumulation or protection against outliving your income.
For someone else, maintaining greater liquidity or accepting market volatility in pursuit of long-term growth may be more important.
The question isn’t simply “Are annuities good or bad?”
A better question is:
“What do I need this portion of my money to accomplish?”
Once you answer that question, it’s much easier to determine whether an annuity—and which type of annuity—belongs in your retirement strategy.
Building a More Predictable Retirement
Retirement planning has changed. Most people can no longer count on an employer pension to automatically provide a paycheck for the rest of their lives.
But that doesn’t mean predictable lifetime income has disappeared.
An annuity can potentially help turn a portion of your accumulated savings into an income stream designed to last throughout retirement. The appropriate product, amount and income option will depend on your financial situation and goals.
Want to Explore Your Options?
Life Insurance Specialists helps individuals and families compare annuity options from multiple highly rated insurance companies.
If you’re approaching retirement or simply want to understand how an annuity might fit alongside Social Security, retirement accounts and your other assets, we’re happy to help you evaluate your options.
