Every week, it seems, there’s another news story about a company eliminating a pension plan in favor of an employee-directed option, like a 401(k).
Retirement plans that give account owners more control allow individuals to make decisions based on personal needs, but there are some things that will always be appealing about pension plans. One of the most important upsides to a pension plan, from an employee’s perspective, is that it offers a steady and predictable income stream during retirement years—a feature many retirement investors believe they need.
Since pensions are disappearing, some investors look to annuities for that constant stream of retirement income. But before you jump into an annuity with both feet, do some research to make sure it’s the right option for your situation. Here are some tips:
Figure out your investor type. There are a wide variety of annuity structures available in the marketplace today. Two major categories are variable annuities and fixed-rate annuities.
Variable annuity owners invest their account balances in mutual fund-style sub-accounts. There’s the potential for higher returns over the life of the annuity, but the tradeoff is higher risk.
Fixed annuities have more guarantees. Though specific numbers may depend upon the date you choose to annuitize (start receiving payments), investors can easily approximate how much income to expect from a fixed annuity during retirement. They’re more conservative, but the lack of variable investing could be detrimental in a high-inflationary period.
Be sure your investment personality is suited to the make-up of your annuity. As with any investment decision, don’t choose based on an emotional response to the current market situation. Instead, devise a long-term plan to meet your needs and your tolerance for risk.
Decide on your goals. It’s imperative to establish your long-term goals before making the final decision to move forward with an annuity contract. In most cases, there are stiff surrender charges associated with the account balance from the day you sign the contract. And once you’ve started receiving payouts, you can’t back out of an annuity contract without suffering heavy penalties.
Make decisions based on your long-term needs. How great is the possibility you’ll need the money from the investment for a large purchase, like a home or medical bills? Check the specifics of your contract to see whether you can take a penalty-free loan from the annuity account or withdraw a percentage of the balance without incurring surrender charges.
You’ll also want to explore and consider the payout options available based on your goals for the income. If you don’t want to outlive your payments, you’ll need to make specific purchase decisions. The same goes if you have a goal to have some assets left to pass along to a beneficiary after your death.
Ask about fees. The fees tacked onto many annuity contracts have given them a bad reputation over the years. Some annuities have more favorable fee structures than others.
Beyond the surrender charges mentioned above, check to see which fees apply to your contract and how expensive they are. Mortality and expense fees, management fees, sales fees, and investment fees are examples. Read the fine print and get everything in writing. If the person you’re working with won’t provide a clear list of the fees involved, walk away.
Investigate the insurance company providing the annuity. Some firms are more stable than others. Since most annuity investors will rely on the annuity’s income stream during retirement, it’s important to purchase an annuity from a company that’s likely to remain in business for many years to come. Moody’s, Standard & Poor’s, and Fitch are some examples.
The company structure may also determine its overall money management philosophy—mutual insurance companies are answerable to contract and policy owners rather than stockholders and may have a longer-term outlook than publicly traded firms.
Also ask about dividend history. Annuity contracts can be structured to receive dividend payments, which are not generally guaranteed. Some insurance companies have a more reliable history of paying out dividends.
If you’ve been thinking these tips look similar to the advice you’ve seen for 401(k) investors, you’re not alone. There are additional topics to explore when thinking about an annuity, such as not putting all your eggs into one basket.
Taking the time to understand your goals and long-term needs will save you headaches down the line, regardless of whether you’re investing in an employer-sponsored retirement plan, an annuity contract through an insurance company, or both. Moreover, as with anything, if it looks too good to be true, it probably is.
Scott Holsopple is the president and CEO of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal. Keep tabs on Scott on Twitter and Facebook.