A big mistake many of us make during our working years is focusing mainly on asset creation. Asset creation is not per-se a bad thing but when planning for retirement, “Income is King.” Assets can be lost, stolen, lose value in a bad market situation, or be subject to disputes, jeapordizing your retirement plans.
“How much money do I need to retire and sustain the existing lifestyle and spending habits?” That thought crosses the minds of most working people at some point in their careers. It is a valid question because retirement often marks the end of a steady income. So, if you hope to continue spending like before or pursue new interests like travel post-retirement, you must have accumulated enough wealth to “decumulate” comfortably.
Typically, people accumulate wealth in savings accounts or investments. However, in recent years, following economic downturns and rising inflation, many financial advisors have included annuities in clients’ retirement planning. Annuities are financial products that provide the investor with a steady stream of income. The investor first pays either a lump sum or a series of instalments to the service provider to stand eligible for the guaranteed income, which can begin immediately or at a later date as per the contract.
In their simplest form, annuities provide guaranteed income to investors for a lifetime, hence ideal for retirement planning. So, they are an insurance as much as they are an investment. Accordingly, annuities come in multiple types and with different add-ons, allowing investors to also receive immediate returns, split the policy and distribute cash values to successors, receive a death benefit, and more. The following sections will delve deeper into various types, the time horizon, potential returns and risks, how annuities differ from typical savings plans, and their utility in retirement planning.
Annuities can outlive savings
The fundamental difference between annuities and savings plans boils down to the purpose they serve: Annuities provide a regular stream of reliable income, whereas savings help build a corpus for expenses such as the purchase of a new house or children’s education. So, while the savings can run out, annuities will continue to pay investors. That translates to better financial security and peace of mind, which are among the foremost considerations for most people before retiring.
Different annuities as per risk tolerance
Fixed annuities, one of the most common types, give the investor a flat rate of returns, irrespective of market fluctuations and inflation. However, variable annuities provide modest returns compared to fixed annuities, as the insurer reinvests your money in stocks, indexes, or other funds tied to market risks. So, the returns depend on the performance of the linked fund.
Similarly, the time horizon impacts the returns of annuities significantly. Immediate annuities pay out right after the premiums are paid, offering flat returns and potentially incurring continuous income tax. However, deferred annuities, which are more suitable for retirement planning, grow on a tax-deferred basis till the “annuitization phase” when the investor begins to receive steady returns. As the investment earns interest during the deferral period, such products are generally more rewarding to investors opting for a long time horizon. In other words, those who start investing in annuities early in their career stand to benefit the most in their retirement.
The growing flexibility in annuity plans
Leading insurers have increased the add-on benefits and rider options in annuities in recent years. For example, the market risks of investment-linked annuities can be mitigated by adding inflation riders (for additional charges). Similarly, annuity riders also provide investors with more benefits than what the base contract allows. Early withdrawals and surrender, guaranteed minimum income, added death benefits, and fast-tracked payouts upon a critical illness diagnosis are among the add-ons making annuities more flexible and attractive for investors of varied risk tolerance. Flexibility allows investors to restructure annuities as they near the retirement age when their risk appetite is likely to change.
In recent years, flexibility has become an important determinant of a good annuity plan. Leading insurers provide the option to pay in instalments, split the policy generationally, and choose varied deferral periods, besides offering accident protection, easy withdrawals, and death benefits. The recent arrival of ESG funds-linked annuity plans has further sweetened the pot, enabling investors to capitalize on the uptrend in green and sustainability-rated assets. All in all, annuity investors now have the unique opportunity to safeguard not only their retirement but also their legacy and succession and create generational wealth.
In legacy planning, annuities can structure the payment of death benefits to beneficiaries and enhance their financial prospects. Additionally, beneficiaries can receive payouts based on surrendered cash value when annuity policies are divided among them. That is to say, such plans will not only provide the retiree with a steady income for a lifetime but also go beyond and define their financial legacy. Such unique possibilities have understandably contributed to the rise of annuities in recent years and will continue to do so for the foreseeable future.
