Buy an Annuity Now or Wait?
With so much volatility in the investment world, many retirees like the idea of a straightforward annuity option. An annuity provides a guaranteed income for life in exchange for a lump-sum payment – kind of like buying a defined benefit pension plan.
In the past, many chose to build up their retirement portfolio over the course of their working life and then purchase an annuity with the full amount on the day that they retire. They would then have a fixed (and guaranteed) monthly or annual income amount that would last as long as they live and there was no risk of running out of money.
While this is arguably the lowest risk option available, it may not be the right option for as many retirees as it used to be. The amount that you will receive from an annuity is based on your age, sex and interest rates. Due to the current low rate environment we’re in, annuities purchased now are paying less than ever.
A simple solution would be to tell you to simply wait until rates increase and buy the annuity then. You would be a few years older and interest rates will have likely gone up so the annuity payment amounts that are locked in for life will in theory be much higher. What if you need income now though? And how long should you wait?
Many “experts” agree that the current sweet spot for purchasing an annuity is age 70. This may not work for many of you though who retire before then and need income right away. One option is to consider “laddering” your annuities. If for example you have $600K saved up that you want to use to provide lifetime income, you could consider purchasing a $200K annuity each year for the next three years. Your income stream (although smaller at the beginning) would start right away and you could hedge your interest rate risk by spreading it out.
A second option is to use a blended strategy. If you and your financial planner calculate your basic living expenses to be $40,000 per year and you receive $18,000 per year from government benefits (CPP & OAS), you could use a portion of your retirement nest egg to purchase an annuity that provides $22,000 per year of annuity payments and then keep the remainder in a diversified investment portfolio. Your basic expenses would be funded for life from the annuity/government benefits and the rest of your portfolio would be available to withdraw from as needed for a big purchase, travel plans or other lump-sum withdrawals.
Who should not buy an annuity? Those of you who already receive the bulk of your retirement income from a pension should probably look elsewhere for investing your remaining portfolio. Likewise if you have a potentially shorter life expectancy due to health issues or family history. If passing on a large portion of your wealth to beneficiaries is a key goal, this again may not be a good fit.
For the rest of you though, annuities might be a great option for a portion of your retirement savings. The key (like any other retirement strategy) is to fully understand the features, benefits and downsides of this type of investment option to determine if it’s right for you. An annuity can take much of the stress of retirement planning out of the picture and provide you with worry-free retirement income for as long as you live. Just make sure that you first determine if this option is suitable for you and make sure you get proper advice on how to tailor the annuity to fit your unique needs.