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Turn Your Savings into a Paycheck With Annuities

Annuities: A Piece of the Retirement Puzzle

Annuities present something of an investment puzzle. On one hand, they can help you simplify your income planning in retirement. But handing over a portion of your savings to an insurance company isn’t always an easy move to make.

First, the sheer variety of annuities can be baffling. There are fixed, variable, immediate, deferred, and equity-indexed annuities—just to name a few. In addition, each annuity can come with a (sometimes lengthy) menu of riders and options that can expand its coverage, sometimes adding cost and complexity.

Despite these hurdles, annuities can offer real benefits if you want to bring order to your retirement-spending plans, says Rob Williams, director of income planning at the Schwab Center for Financial Research. “Annuities can provide insurance for your retirement,” he says, helping to mitigate some of the risks, such as market and longevity risk, that retirees face.

A valuable complement

An annuity is a contract with an insurance company. Depending on the type, you typically pay either a lump sum or an annual fee, and in return, the insurer generally promises to pay you income for a set period of time—or for the rest of your (and potentially your spouse’s) life, when you start taking income. Of course, payments and other guarantees from annuities are subject to the financial strength and claims-paying ability of the issuing insurer.

Whatever type of annuity you choose, know that you don’t have to hand over your entire life savings. In fact, Rob suggests committing no more than half of your investable assets to annuities and says it’s better to think of these products as just one potential part of a larger retirement-spending plan.

Rob says it’s helpful to divide your potential sources of retirement income into two categories:

  • Predictable sources of income, which could include Social Security, pensions and annuities. Use this income to cover essential expenses, like housing, food and supplemental healthcare costs. It’s your baseline.
  • Portfolio income, which is more variable, includes dividends, capital gains, interest from bonds, and distributions from IRAs, 401(k)s and investment accounts. Use this to pay for discretionary expenses such as travel and entertainment. At the same time, knowing your essentials are covered by your predictable income streams should give you the confidence to keep more of your portfolio invested for growth over the long run.
Chart 1: Match your retirement income to certain expenses

Another option is to calculate how much of your retirement income will come from other predictable income sources, such as Social Security, and divide that by your total retirement income needs. For example, if Social Security will cover 20% of your income needs, then 80% will have to come from your portfolio. Does this feel like too much risk to you? If so, consider boosting that guaranteed income percentage with annuities.

The benefits of guaranteed income

Using an annuity to create a predictable income stream can help address some common retirement needs. Here are some:

  • Annuities provide steady income. Figuring out how much you can withdraw from your 401(k)s, IRAs and other investment accounts each year is no easy task. Placing some assets from such accounts in an annuity can help smooth things out. “Annuities can help turn a lump sum into a disciplined series of paychecks or distributions,” Rob says, “and creating a disciplined spending plan, for a least a portion of your essential expenses, can be one of the more difficult tasks in retirement.”
  • You can plan and spend more comfortably. Many of today’s retirees are living longer, and for many couples there’s a good chance one spouse will live past age 90. Dedicating some assets to annuities to provide income that you—and potentially your spouse—can’t outlive can take the pressure off your investment portfolio.
  • You can better manage market swings. One annuity, called an immediate income annuity, delivers steady payouts that aren’t subject to market volatility. When you buy one, you’re effectively transferring your market risk to an insurer. That can alleviate financial worries during a bear market and minimize sequence-of-returns risk—helping you avoid taking withdrawals from investment accounts when they’re down and, potentially, managing the rest of your portfolio more flexibly.
  • Annuities can keep your plan on track. At 85 or 90, you may not have the desire or cognitive capacity to actively manage your investment accounts and maintain a withdrawal plan. Steady annuity payouts can simplify your retirement income.

Two annuities to consider

  • An immediate income annuity: Also known as a single premium immediate annuity, this can be a smart option if you want fixed payments that won’t fluctuate based on the markets. You make one lump-sum payment, and the payouts start immediately.
    One thing to note: The payments are based in part on interest rates (along with the size of your initial lump sum, your age and other factors) at the time of purchase. Pouring a large chunk of your assets into a single premium immediate annuity when rates are low might not make sense. One strategy would be to buy several immediate income annuities over time, a strategy called “laddering,” spreading out your annuity purchases and boosting your payments as your guaranteed income needs grow.
  • A variable annuity and a guaranteed lifetime withdrawal benefit (GLWB): If you don’t need immediate income and would prefer to keep your money invested—but you still want a reliable source of income down the road—this could be an attractive option, Rob says.
    With this product, your money is invested in the markets, where it benefits from the potential for tax-deferred growth. By annuitizing the contract, you can begin receiving guaranteed income for life based on the performance of the underlying investments. If you want further assurances for your income, you can purchase an optional rider called a Guaranteed Lifetime Withdrawal Benefit (GLWB), which guarantees you a minimum level of lifetime income. If the portfolio’s value rises, your income can rise. If you want protection from market fluctuations, Rob suggests purchasing the optional GLWB rider as it ensures that your eventual withdrawals will never be lower than a pre-determined minimum. (But note that the GLWB protects your income only, not your contract value.)
    Another important factor to consider when thinking about an annuity is the cost, says Rob. The fees can vary widely, with variable annuities typically carrying higher annual costs than immediate income annuities. And if you add a GLWB option to a variable annuity, it can increase the annual fees you pay by roughly 1% of assets under management, per year. Shop around, and look for a variable annuity with the riders that make the most sense to you, at a cost you’re comfortable with in exchange for the protections provided.

“Remember,” Rob says, “annuities add insurance for your retirement, and while it’s tempting, try not to compare them exactly to investments in your portfolio.” Annuities are designed to protect you from challenges in retirement that are difficult to manage on your own and to help ensure you’ll have income for the one “risk” you want to experience—a long, comfortable retirement.

What you can do next

The best annuity for your portfolio depends on your specific situation and risk tolerance. A financial consultant can help you weigh your options and understand the costs.

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Important disclosures:

Variable annuities are sold by prospectus only. You can request a prospectus by calling 888-311-4887 or by visiting schwab.com/annuity. Before purchasing a variable annuity, you should carefully read the prospectus and consider the annuity's investment objectives and all risks, charges and expenses associated with the annuity and its investment options.

The contract value of a variable annuity may be more or less than the premiums paid and it is possible to lose money.

All annuity guarantees, including an annuity's payment guarantees, are provided by and only as strong as the financial position and claims-paying ability of the issuing insurance company. Neither Schwab nor its affiliates provides insurance or other guarantees. Consult the insurance company's ratings for its financial strength and read the annuity contract and/or prospectus before investing. Insurance company ratings do not apply to the performance of variable subaccounts. Ratings are subject to change.

The Guaranteed Lifetime Withdrawal Benefit is an optional rider available for an additional charge. It is not a contract value, cannot be accessed like a cash value, and will not preserve your account value, which will deplete with each withdrawal until it reaches zero, though payments under the terms of the rider will still continue for life. On certain contracts, the GLWB must be elected at the time of purchase and cannot be changed later. Upon electing the rider, you may be limited to a pre-specified selection of investment options. Withdrawals in excess of the specified annual payout amount may permanently and significantly reduce your future income.

Variable annuities are long-term investment vehicles designed for retirement purposes and offer tax deferral on potential growth; however, withdrawals prior to age 59½ may be subject to a 10% federal tax penalty in addition to applicable income taxes. Variable annuities are also subject to a number of fees including mortality and risk expense charges, administrative fees, premium taxes, investment management fees and charges for additional optional features. Although there are no surrender charges on the variable annuities offered by Schwab, such charges do apply in the early years of many contracts.

Charles Schwab & Co., Inc., a licensed insurance agency, distributes certain life insurance and annuity contracts that are issued by non-affiliated insurance companies. Not all products are available in all states.

The information presented does not consider your particular investment objectives or financial situation and does not make personalized recommendations. This information should not be construed as an offer to sell or a solicitation of an offer to buy any security. The investment strategies and the securities shown may not be suitable for you. We believe the information provided is reliable, but Charles Schwab & Co., Inc. ("Schwab") and its affiliates do not guarantee its accuracy, timeliness, or completeness. Any opinions expressed herein are subject to change without notice.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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