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Introduction
There are many questions facing retirees or soon to be retirees. What will I do and how will I keep myself busy? Should I work part time? Will my nest egg be enough to carry me through? And one of the ultimate questions, will I be able to retire comfortably?
For some Americans, maybe a 401k was not really an option. Perhaps you worked for a small business who never offered one. Or maybe you’re one of the many millions of workers who needed to tap into their 401k funds early for one reason or another. What other options might there be? One popular option that has been around for many years is an annuity. Annuities appeal to many people because of the guaranteed income they can provide. But the question this article seeks to answer is, is an annuity alone enough for a comfortable retirement?
What Is an Annuity?
There are many reasons people buy annuities, below are some of the most common.
| Reason | Description |
|---|---|
Guaranteed Income | Provides a reliable stream of income, often for life, ensuring financial security. |
Protection Against Longevity Risk | Reduces the risk of outliving one's savings by offering lifelong income. |
Stress Reduction | Decreases anxiety related to market volatility, as returns are typically stable. |
Budget Simplification | Makes financial planning and budgeting easier due to predictable income. |
What “Comfortable Retirement” Really Means
To really answer the question of whether an annuity, alone, is enough for a comfortable retirement, you’ll need to define what a “comfortable retirement” really means. This is very subjective in nature; one person’s perfect retirement may be another person’s nightmare retirement. But below we provide a framework for trying to figure out what “comfortable” may mean to you.
| Consideration | Details | Comment |
|---|---|---|
Subjective Nature of Comfort | Basic needs vs. lifestyle goals | Determining what you “need” vs. what you “want” prior to retirement will be important. |
Healthcare Costs | Account for potential medical expenses | Being realistic about one’s health will play a crucial role in how prepared you really are for retirement. People are living longer than ever, and medical expenses don’t get any cheaper as we age. |
Travel and Hobbies | Include anticipated spending on leisure activities | If you’ve always wanted to take that months long European vacation, proper planning is key to ensure this trip of a lifetime doesn’t adversely affect your nest egg for the future. |
Inflation | Factor in the rising cost of living | As of this writing, we are experiencing a sustained period of high inflation that began in 2021. It is essential to consider the increases in the cost of living, particularly as life expectancy rises. |
Varying Income Needs | Consider different phases of retirement | Planning for future expenses in various phases of retirement is important. These expenses may include travel during the early years of retirement, contributing to college expenses for grandchildren or children, managing healthcare costs as you age, and considering long-term care needs. |
When Might an Annuity Be Enough?
To be clear, relying on just an annuity (and maybe a pension plus Social Security) will be difficult. But here are few things to consider if that is your goal.
The more income streams available to you, the better. Some people may consider Social Security an unreliable source of income. But for now, Congress has no real plans to drastically alter benefits for retirees. Since most Americans are required to pay into Social Security, it’s a relatively safe bet that you and your spouse will have this source of income to supplement your annuity. This added benefit is that Social Security benefits are adjusted for inflation annually.
Though fewer and farther between, even for public sector workers, pensions can also provide added stability to your retirement. The primary issue with pensions is that they generally are not adjusted for inflation.
Numerous studies have shown that working part time has many benefits in retirement. Not least of which is supplementing any income from annuities.
But if you do not want to work part time and/or have had no access to a workplace pension plan then focusing on where your money goes in retirement will be key.
Debt: Making sure you enter retirement debt free should be the goal for anyone close to retirement. This would mean having a good reliable car paid for. Having your mortgage paid off or any home equity loans or lines of credit paid off as well. With interest rates for credit cards north of 25%, having no credit card debt will also be a crucial factor for a comfortable retirement.
Living Expenses: As stated above, the different between “need” vs “wants is going to be different for each person. But having a good understanding of what your expenses may be in retirement will be crucial for any retirement income planning.
Why a Diversified Approach Is Often Better
When considering annuities as part of your retirement plan, it's essential to weigh both their benefits and drawbacks. Below are some key points to keep in mind:
Lack of Liquidity: Annuities often limit your access to funds, which can be restrictive during financial emergencies.
Inflation Risk: Fixed annuities may not keep pace with inflation, reducing your purchasing power over time.
Fees and Charges: Annuities come with various fees, including surrender charges, which can erode your investment.
Complexity: Understanding annuities can be challenging due to their intricate terms and conditions.
Wealth Accumulation: Annuities are generally not designed for growing your wealth or leaving a legacy.
Diversification: It's crucial to combine annuities with other retirement assets such as 401(k)s, IRAs, and investments to maintain a balanced portfolio.
Flexibility and Liquidity: Ensure your retirement plan allows for flexibility and access to liquid assets when needed.
Conclusion
It is certainly possible that an annuity can be the primary means of income for a comfortable retirement. But for the average retiree a good mix of traditional retirement accounts (401k, IRAs, etc.), debt reduction and possibly part time work will provide the best opportunity for a stress-free retirement.
"Comfort" in retirement encompasses security, flexibility, and strategic planning. These elements will vary for each individual retiree. Careful planning with a financial advisor or retirement income planner is essential to ensure that your retirement years are as comfortable as possible.