Annuities for retirement: 7 ways they build financial confidence

Millions of Americans worry about whether their savings will last throughout retirement, a fear that has pushed many to explore options such as annuities for retirement.

Nearly two-thirds of savers worry they will run out of money during retirement, according to a recent BlackRock survey. An overwhelming majority — 86% — say they want a guaranteed income to reduce those fears.

An annuity can provide a steady, guaranteed income throughout your golden years. And those who own annuities feel more positive about their retirement.

More than three-quarters of annuity owners —76% — are confident they will be able to retire when they want, according to a recent Nationwide survey. Just 49% of those who do not have an annuity feel the same way.

Why do annuities boost retirement confidence to such a degree? Here are seven key benefits of using annuities for retirement.

What are annuities and how do they work in retirement planning?

An annuity is an insurance contract designed to provide income, typically in exchange for a lump-sum payment or a series of contributions. Typically, you either make a lump-sum payment or periodic payments prior to receiving a steady stream of income from the insurer.

Most people look to annuities to provide a steady income during retirement, although many people purchase annuities years before retirement begins.

There are many different types of annuities, including:

• Fixed-period annuities: Also called period-certain annuities, these pay the same amount of income to an annuitant over a set period.
• Variable annuities: Offer payouts that can change based on the performance of underlying investment portfolios.
• Single-life annuities: Pay a fixed amount at regular intervals and end at the annuitant’s death.
• Joint and survivor annuities: Continue payments to a surviving spouse or second annuitant after the original annuitant dies.

Other types of annuities are also available, and selecting the right annuity will depend on your financial needs and goals.

Key components of retirement annuities

When you purchase an annuity, there will be two phases: the accumulation phase and the distribution phase.

During the accumulation phase, the annuitant builds a pool of cash value in the annuity. The annuitant will make either a lump-sum payment or periodic payments during this phase. Money invested in the annuity grows tax deferred.

When the distribution phase—sometimes known as the annuitization or payout phase — begins, a steady stream of payments to the annuitant will commence.

Now, let’s move on to the seven benefits of annuities during retirement.

1. Retiring on your own timeline with annuities

Many people take great comfort in knowing that they will receive a steady stream of income in retirement regardless of how the stock market and overall economy perform.

Retirement annuities can help provide this certainty. In fact, the Nationwide survey found that 70% of annuity customers were confident that their annuity payments would continue as promised.

By contrast, just 61% said they were certain they would receive their full Social Security benefits.

This confidence in annuities is a big part of why more than three-quarters of annuity owners are sure they will be able to retire on their desired schedule. Knowing that you will receive steady payments without fail is like getting a steady paycheck during your working years.

By contrast, those who have a nest egg invested in the stock market could see their accounts cut in half — or more — in a market downturn that is completely outside of their control. This can be particularly devastating emotionally and financially if you need access to money when markets are near their lows.

2. Reliable monthly income you can count on

A lifetime income annuity provides guaranteed lifetime income that is like a monthly Social Security payment. Monthly payouts depend on factors such as age, interest rates, and current lifetime annuity rates. Regardless of what is happening in the economy, you receive a steady stream of income that can help you make ends meet in retirement.

For example, plugging the numbers into the online calculator at Annuity.org, you discover that a 65-year-old woman in New York who purchases a single-life annuity for $150,000 that begins payments in one year can expect a little less than $1,000 in monthly income.

By delaying payments for a few years, you can increase the monthly payout. If the woman in the prior example waits five years before receiving her payments, the amount she will receive jumps to around $1,200 a month.

Annuities can provide a real boost to monthly income, especially when paired with income from Social Security. Knowing that you will receive payments for the rest of your life can help to relieve fears that you might outlive your savings if you live well into your 80s or 90s.

Calculating your annuity retirement income needs

Your spending wants and needs likely play a big role in determining how much annuity income you require during retirement.

Creating a budget can help you gauge how much you spend each month and whether purchasing an annuity would be a wise way to boost income. Online calculators might help you determine how much annuity income you require. Or you could sit down with a financial advisor for more guidance.

3. Market-proof peace of mind in retirement

A guaranteed income annuity can offer a steady stream of monthly income throughout retirement. This can offer tremendous peace of mind to many retirees. If the economy goes south or the stock market crashes, you will still be able to count on annuity income.

By contrast, a nest egg that is invested in stocks could see its value plummet at any time. Retirees have learned this lesson the hard way, most recently during the Great Recession, when the S&P 500 index lost roughly half its value.

The hidden cost of market volatility in retirement

If you are retired and need to withdraw money from your nest egg when the stock market is down, you will lock in your losses for good.

This is known as “sequence-of-returns risk,” and it can have a devastating impact on your ability to ensure you don’t run out of retirement savings before you run out of life.

How annuities shield your retirement income

When you purchase an annuity, you are also buying the promise that you will receive guaranteed income for a period of time. With a lifetime annuity, payments typically continue for the rest of your life, and some contracts include survivor benefits for a spouse.

Purchasing a fixed annuity means you will receive predictable payments over a set period or for life.

If you like to roll the dice a bit, you can purchase a variable annuity that can either increase or decrease your payment based on stock market performance.

4. Greater confidence to spend during retirement

Those who own annuities say they feel greater peace of mind over their finances. And research indicates that they are more likely to spend on wants and needs as a result.

The psychology of retirement spending

Nearly all — 97% — say their annuity helps them worry less about running out of money, according to a BlackRock survey.

In addition, 93% say they worry less about daily expenses because they know they have a steady stream of income from an annuity.

Annuities even help people worry less about their investments, with 88% of annuitants agreeing that their annuity eases anxieties about a possible stock market swoon.

Some retirees become extremely tight-fisted, afraid to spend money now that they no longer receive a regular paycheck from an employer. This can actually lead to underspending and reduced satisfaction during retirement.

However, BlackRock found that 53% of those who have an annuity feel more comfortable spending money from their nest egg if there is something they either want or need to purchase.

Balancing essential and discretionary spending

While owning an annuity can make you less hesitant to spend money, you still need to create a budget so you don’t overspend.

Some types of spending are essential and unavoidable, such as paying the mortgage and covering health care costs. But others are discretionary, such as buying fancy cars and taking exotic trips.

Annuities provide income, but they won’t necessarily make you rich. It’s important to make sure you use annuity proceeds to cover your essential needs. Then, if you have enough money left over, you can consider the occasional splurge.

5. Tax advantages of annuities in retirement planning

Tax-deferred growth is one of the biggest perks of deferred annuities. With this type of annuity, you build funds for years before you begin to receive income. As these funds accumulate, they grow tax-deferred, much as they would in a 401(k) or IRA.

When you begin to receive income from your annuity, earnings will generally be taxed as ordinary income. However, with careful planning, you can arrange your finances so that payouts arrive in a manner that keeps you in a lower tax bracket.

Tax-efficient withdrawal strategies

For example, combining withdrawals from an annuity with tax-free withdrawals from a Roth 401(k) or Roth IRA — or even from a health savings account — can help keep you in a lower tax bracket.

Once again, this is an area where sitting down with a tax professional can make a big difference in terms of how much you owe in taxes.

Tax considerations for different annuity types

It’s important to note that you can fund annuities in two different ways: with qualified or unqualified sources of money.

Pre-tax money — such as in a 401(k) or IRA — is used to fund qualified annuities. On the other hand, taxable contributions are used to fund non-qualified annuities.

These differences play a role in how an annuity’s payouts are taxed.

6. Strategic investment flexibility with secure income

Along with Social Security benefits and pension payments, annuities can provide a steady stream of income that is much like a paycheck from an employer.

This concept is sometimes referred to as the “flooring approach,” where guaranteed income covers essential expenses.

The bucket strategy with annuities

Some retirees divide retirement savings into three buckets:

• Short-term needs
• Mid-term needs
• Long-term needs

7. Legacy planning with retirement annuities

There is a misconception that annuity income always ends with the death of the annuitant. But this is not necessarily the case.

For example, many annuities include a death benefit feature that will pay out money to a beneficiary you name.

Types of annuity death benefits

• Standard return of premium: Pays the remaining annuity value to beneficiaries.
• Enhanced death benefit rider: Increases the payout to beneficiaries.
• Joint and survivor options: Continue payments to a spouse.

Balancing income needs with legacy goals

Annuities can help provide a steady income while also supporting legacy planning goals.

Getting started with annuities for retirement

Annuities can play an important role in creating reliable retirement income. Review the size of your savings and compare it with your expected expenses.

If you are unsure whether an annuity fits your plan, consider consulting a financial advisor who can help evaluate your options.