With returns on many investments at less than optimal levels, some people are turning to annuities as an alternative that might protect them against market risk. But 2016 is shaping up to be "a tricky year to buy an annuity," says Andrew Murdoch, president of Portland, Oregon-based Somerset Wealth Strategies, which sells annuities and other retirement products.
2 factors behind the murkiness
The Society of Actuaries, the organization on which insurance companies rely to predict mortality, increased its estimate in 2014 of how long people are likely to live by about 2 years compared with 2000. As a result, insurance companies have begun reducing annuity payouts by as much as 10%.
At the same time, interest rates are rising. That could be a good thing, encouraging insurance companies to raise annuity interest rates to stimulate annuity sales, which have fallen off. But don't expect it to happen right away, Murdoch says, because the increases are coming slowly.
Some other things to consider: If you are expecting an old-fashioned defined benefit pension and you were considering taking the lump sum, do some investigation before you make an irrevocable decision. Most employer pension amounts were locked in long ago, when annuity payouts were higher than they are now. "You may be grandfathered into a very favorable rate," Murdoch says.
Teacher and other state pensions usually have annuity minimums that are particularly attractive, Murdoch adds.
Shop around if you're considering annuities
There is a considerable range in payouts. Some insurers are definitely more generous than others.
Typical monthly income on a $100,000 immediate annuity
Represents lifetime income for a couple, assuming both are the same age, with a guarantee of 10 years' payments, even if both die within the decade.
|Age||Highest||Taxable portion||Lowest||Taxable portion|
Source: Somerset Wealth Strategies and Annuityfyi.com
Besides the monthly income amount, here are a couple of other things to consider:
- Taxable amount. If you use pretax money from an IRA or a 401(k) to purchase the annuity, then all payouts will be fully taxed. If you use after-tax dollars to buy the annuity, then a portion of the payouts will be a tax-free return of your principal. You'll owe taxes on the remainder at your ordinary income tax rate.
- How financially solid is the insurer? Look at the credit ratings of the insurance companies you are considering. The best have A+ or even A++. Murdoch says that B++ is the lowest rating worth considering.
- Don't worry that you haven't heard of the insurer. "If they have good credit ratings, but they just don't advertise, that isn't a reason to avoid them. Some companies don't advertise, and they use the money that they are saving and improve the annuities," Murdoch says.
- There is no reason to buy just 1. Laddering the purchases over 5 years, 7 years and 9 years, for example, gives you the possibility that rising interest rates will drive up the payouts.
- Consider the QLAC. Buying a qualified longevity annuity contract in your 401(k) or conventional IRA will delay the IRS demand that you start paying required minimum distributions, or RMDs, at age 70 1/2. Depending on your situation, this could be a significant tax saver.
- Health costs make it a gamble. The rising cost of health care can make the flat payout on an annuity a bad bet, according to research by the Congressional Budget Office and The Wharton School of the University of Pennsylvania. The report concluded that when annuity values are correlated with long-term care costs, the inability to get cash from your nest egg could leave you in a jam.
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[Editor's note: An earlier version of this post incorrectly stated that the American Academy of Actuaries releases mortality tables on which insurance companies rely. It's actually the Society of Actuaries that releases these tables.]