Besides enabling clients to leave their savings untouched, he says, annuities allow them to invest those other assets more aggressively, if they wish, confident that the annuity is providing the security of guaranteed income.
Weighing Options
For some, annuities may seem like the only choice. Those who retire early “often have no alternative to meet their income needs,” observes Jason Fichtner, senior fellow at the Alliance for Lifetime Income and a senior lecturer at Johns Hopkins University’s Paul H. Nitze School of Advanced International Studies in Washington, D.C. “Bridging the income gap is a problem that annuities are uniquely qualified to address.”
But even so, it’s important to realize there are many types of annuities available. Advisors should tailor recommendations to individual client situations “as part of a comprehensive financial plan,” says Fichtner.
The best annuity to bridge an income gap may be a fixed-term single premium immediate annuity (SPIA). “These offerings would pay out a steady stream of income for a set period of time,” explains Todd Giesing, senior director of annuity research at data tracker Secure Retirement Institute in Windsor, Conn. After that time is up, the payments stop. But “the customer would have received all of their principal—and possibly more—back in payments,” he says.
On the other hand, a long-term annuity will pay out longer and can “lay a foundation that Social Security payments will ultimately add to,” says Frank O’Connor, vice president of research and outreach at the Insured Retirement Institute in Washington, D.C.
Whether it pays a variable or a fixed rate, an annuity with an added guaranteed lifetime income benefit would provide income you can’t outlive. Many annuities also enable you to turn the income spigot off and on as needed.
“Once you start taking Social Security [you can] turn off the income in the annuity, which would allow future income to grow,” says Laird Johnson, senior director of advanced markets at Equitable in New York. “Some of the [income] riders can be very flexible.”
The Non-Annuity Options
Other advisors, however, are not so sure annuities are the best way to go. “The problem that I see today is that interest rates are still at multiyear lows, so the [annuity] payout will be significantly lower,” says Luis Strohmeier, partner and wealth advisor at Octavia Wealth Advisors in Los Angeles. “Advisors really have to do their homework.”
As interest rates rise, though, annuity payout rates will rise, too. Then again, so will bond yields. That’s why some experts are sticking with bond ladders—buying bonds with different maturity dates to stagger payouts.
Russell Story at Story Wealth Management Group in Douglas, Ga., acknowledges that a set-term annuity “can be used when someone needs ‘bridge income’ while waiting for Social Security payments to begin.” But sometimes a better option is withdrawing funds from nonqualified investments, on which you only pay taxes on the gains realized. “This is where planning can pay,” says Story.
Alternatively, he says, you could take penalty-free early withdrawals from retirement accounts, as described in Section 72(t)(2) of the Internal Revenue Code. To qualify for that, you must take at least five equal payments over five years or over the time you have until you reach age 59½, whichever period is longer. The size of the payments allowed depends on the Internal Revenue Service’s complicated life expectancy calculus.
With equity prices at record levels, shifting savings into lower risk assets may make sense. Tom Henske, a partner at Lenox Advisors in New York, says that 60-year-old clients who are looking at early retirement today should probably consider rebalancing their portfolios to move money out of equities after recent market gains. “They could use some of that savings in their qualified plans,” he says, but “you’d really need to run the math on individual client situations.”