With the Federal Reserve interest rates rising, annuities may seem like an attractive retirement income strategy. After all, higher interest rates should mean higher guaranteed income. But there are a few considerations savers should take into account first.
The central bank raised the target federal funds rate by three-quarters of a percentage point to a range of 1.5% to 1.75% – the biggest rise in nearly 30 years. He also said he plans to raise the rate to around 3.4% by the end of this year and almost 4% by the end of 2023, before expecting to cut rates l ‘Next year.
A rate hike has advantages and disadvantages for the average consumer. For one thing, borrowers will have to pay more for their loans, which means planning more (and paying more) for big-ticket items, like a house or a car. Conversely, savers and retirement planners may benefit from higher interest rates. Banks may start raising rates on their savings accounts, and annuity rates may rise, for example.
Investors focused on retirement may find annuities a respite from stock and bond markets that have been crushed as inflation soared towards 9%. and inflation constraints, too, since they are intended to provide guaranteed income to retirees when chosen correctly.
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Annuities have gotten a bad rap in recent years, partly because they are insurance products and there has been mistrust of the sales process. Investors should also understand the fees and stipulations associated with the products they are considering for their own retirement journey.
First, know the type of annuity you are buying (or offering): fixed income annuities, which provide a fixed amount of money on a scheduled basis; variable annuities, which are linked to an investment portfolio; and immediate annuities which are paid with a lump sum of money.
Also understand how economic factors can affect your retirement income from an annuity. For example, one that offers a fixed payment may not be great when inflation rises because purchasing power will decline as day-to-day expenses become more expensive, said Eric Nelson, certified financial planner and founder of Independence. wealth.
The Fed’s rate hike leads to higher rates for fixed annuities and a higher cap rate for fixed-index annuities, said David Stone, chief executive of RetireOne, an insurance and annuity company that works with finance professionals. (A cap rate is the growth limit of an indexed annuity). “Over the past 12 to 15 years, rates have been so low that people have been rejecting annuities,” he said. “This is the first time in a long time that annuities have had high rates.”
Working with a financial planner, especially one who acts as a fiduciary and therefore in the client’s best interest, is crucial, said Byrke Sestok, Certified Financial Planner and President of Rightirely Wealth.
Because there are so many types of annuities and they come from a variety of providers, the journey to finding the right one can seem overwhelming or complicated. A wrong choice could cost investors money and lead to undue stress.
When choosing an annuity, investors should ask themselves two questions: how much and how they want to receive money from these products, such as monthly or annually, and how they plan to fund the annuity.
Some retirees may prefer to put only a portion of their retirement assets into an annuity – just enough to match their fixed monthly expenses. In such a scenario, retirees may choose to finance “the extras” (an emergency fund, a trip, an unexpected expense, or a new hobby) with other sources of income, such as Social Security or a withdrawal. 401(k).
Also see: Annuities – do you love them or hate them?
Even when you choose to invest in an annuity, these products shouldn’t be treated as the ultimate solution for retirement income, advisers warn. A slowdown in the stock market may have pushed retirement account balances to uncomfortable levels for some investors, but it also “presents a significant buying opportunity in the months ahead,” Sestok said. Investors may have to wait three to seven years for the investment period of a fixed annuity, meaning available assets that would grow with the market will not be available. “Potential outperformance can be enhanced when money is invested closer to the bottom of the market,” Sestok said.
Planning for retirement income involves several factors, including retirement accounts, pensions if available, annuities, social security, and any other cash inflows a retiree can expect in old age. “Annuities are like grain, they’re just part of a healthy portfolio,” said Wheeler Pulliam, Certified Financial Planner and Founder of Xponify Financial. “Beware of positioning them solely as a return-generating investment.”
Instead, think of annuities as a way to secure a portion of your overall retirement income, Pulliam said. And aim to invest no more than 20% to 40% of an overall portfolio in an annuity, he added. “If you follow these principles instead of running after rising rates, your wallet will thank you.”