The Best Age to Purchase an Annuity
While the best age to purchase a deferred annuity will be different for each annuity investor, financial planners generally agree that sometime between the ages of 45 and 55 is optimal. Combined with additional retirement savings vehicles, the compounded tax-deferred interest earned and guarantee of lifetime income can provide a substantial retirement nest egg.
Age Time Frame
Between the ages of 45 and 55, an annuity investor is usually able to take on more risk with his or her investments than an older investor, as there will be more time for someone in that age group to make up for any losses. He or she also has a number of annuity options that are suited for individual financial goals and risk tolerance.
Beyond age 59, annuity investors are more likely to purchase an immediate annuity to provide guaranteed monthly income, as they fall outside the IRS 10% early withdrawal penalty. While an older annuity investor has the same choices a younger investor has, the often shortened time frame makes some of these options more suitable than others.
What Annuity Investors Should Know About Market Risk
Annuity investors have three choices when it comes to selecting an annuity: Fixed, variable and indexed. The choice should be based on how old the investor is at the time of purchase, his or her risk tolerance, and the investor’s plan for the money.
A fixed annuity is generally suitable for an older investor who has fewer years to save for retirement and who prefers to take fewer financial risks. Risk aversion can mean that either the investor does not want to risk money in the market, or it can mean that his or her portfolio already contains other investments that carry significant risk.
A fixed annuity will pay a guaranteed amount, both as the rate of return before payouts begin and as monthly income after payouts begin. Returns between 3% and 10% are currentlycommon, which can be higher than other retirement savings vehicles such as CDs, but also depend on the current interest rate environment.
Because a fixed annuity is almost always purchased with a single premium, an investor can purchase as many fixed annuitiesin any amount that he or she chooses. This can be ideal for investors receiving proceeds from the sale of stocks, bonds, a house or those who receiving a substantial inheritance.
An investor who opts for a variable annuity also opts to be in the market. The premium paid to the insurance company is placed in special accounts that invest in stock, bond or money market funds, or a combination of all three. The investor can choose among aggressive, moderate or conservative funds, and be paid for the gains.
Even though the risk of a variable annuity can be greater than that of a fixed annuity, the investor can minimize the risk by selecting diverse funds and investments options. For those investors who have several years until retirement or until they will need to begin taking distributions, aggressive growth can compound quickly. It is important to realize, however, that any gains are not guaranteed and investors also risk losing not only potential interest, but principal in the amount that they have invested.
Unlike the monthly payout of a fixed annuity, the payout of a variable annuity will fluctuate based on the performance of the underlying funds. Investors interested in variable annuities are advised to have additional assets and access to cash for monthly expenses. While the returns can be greater than those of a fixed annuity, principle is at risk and the losses can be severe.
An indexed annuity is really a cross between a fixed annuity and a variable annuity. It is tied to market performance, most often the Standard and Poor’s 500 index. However, the returns are usually capped on the upside and contained on the downside. For example, if the upside cap is 6%, the investor will earn 6% even if the S&P 500 increases by 7%. And, if the downside limit is 3%, the investor will earn 3% even if the S&P 500 loses 4%.
A major advantage to an indexed annuity is that principle is not risked. No matter how drastic the decline of the index, the only risk is to the interest earned. This is the perfect scenario for investors who wish to participate in the stock market without the taking on unnecessary risk.
Annuity Investors Looking for Guaranteed Lifetime Income
As Americans live longer, they run the risk of outliving their savings. Historical data shows that while the stock market does present a risk of loss over shorter periods of time, in the long run, it out-performs all other methods of savings and growth of savings. Financial planners and actuaries know that the longer a person lives, the longer he or she is likely to live. In other words, while the average life expectancy of an American male is now 78, a man who reaches this age is quite likely to live until age 85.
A retirement account in effect must perform two tasks: It must last at least as long as the person who owns it and it must grow at a rate that is greater than inflation. Next to outliving his or her savings, the greatest risk to a retired investor is inflation. In addition, some investors may want to ensure that a surviving spouse has a guaranteed lifetime income following the death of the original annuitant.
He or she may also want to ensure that a life insurance option, one that offers a death benefit to a spouse or other beneficiary, is available. Further, a cost of living adjustment may be desired as an additional protection against inflation.
All of these options are available with the three types of annuities listed above. The annuity that is best suited for each investor will be the one that meets the majority of his or her financial goals while taking into account the level of risk tolerance and ability to manage the investment. No one annuity or financial product will meet all of an investor’s goals. Each investor is advised to thoroughly review the annuity prospectus and contract to ensure it matches his or her needs as closely as possible.
Annuities are best suited for long term investors. Any withdrawal prior to age 59 ½ is subject to a 10% tax penalty as well as regular income tax. Annuities often also have a surrender schedule, meaning that withdrawals may be subject to a penalty by the insurance company if not left in for a predetermined amount of time. Any guarantees on principal invested is based upon the claims paying ability of the underlying insurance company.