WHY PURCHASING AN INCOME ANNUITY MAY NOT MAKE SENSE
Guaranteed income annuities (also known as immediate fixed annuities) are becoming increasingly popular as a result of recent stock market volatility. When you purchase an income annuity, you give an insurance company a lump sum of money and they send you a check for a fixed amount every month for as long as you live. Purchasers of these products no longer see their nest egg fluctuate with the market, and can count on receiving some income every month for the rest of their lives. But for retirees looking to guarantee themselves a monthly income, is purchasing an annuity from a private insurance company the best use of a nest egg?
As opposed to giving a lump sum to an insurance provider to purchase a guaranteed annuity, a retiree could use their nest egg to support themselves during the initial years of retirement while allowing their Social Security benefit to increase. No lump sum to a private party is ever required. However, you’ll receive the added security that an income annuity provides — a larger guaranteed monthly income.
Similar to a guaranteed annuity, Social Security is another source of lifetime guaranteed income. Additionally, your Social Security benefit rises each year you delay taking payments. If you take benefits at your full retirement age (66 for most people), your benefit will be 100% of your PIA (or primary insurance amount). If benefits are taken at age 62, you will only receive 75% of that PIA and if benefits are taken at age 70 you will receive 132% of your PIA. Thus, by delaying benefits, you are increasing the size of your guaranteed monthly income – essentially accomplishing the same goal that purchasing an immediate income annuity would serve.
Insurance companies need to make money. They also have marketing, management, and risk-bearing costs to cover. Each of these factors reduce the monthly amount they can pay you and remain profitable. As Social Security doesn’t need to turn a profit, it can essentially offer higher returns. For example, consider a retiree who could receive $15,000 a year in benefits at age 65, or $16,075 a year at age 66. By foregoing a year of Social Security income ($15,000), the retiree will receive an extra $1,075 each year for the rest of her life. This is similar to paying a $15,000 lump sum for an annuity that will pay $1,075 annually going forward. The annuity rate on such a purchase, which is the additional income as a percent of the cost, would be 7.17% ($1,075 / $15,000). That annuity rate is likely two to three percentage points more than an insurance company could currently offer.
Additionally, most annuities don’t adjust payments upward to keep pace with inflation, nor do they pass to the spouse of an annuity purchaser. While these features can be purchased from the insurance company at a steep price, inflation protection and survivorship benefit are automatically included with Social Security at no charge.
Finally, an underlying concern with all insurance products is that the insurer could go bankrupt and not pay its obligations. Of course, there is no such concern when the insurance provider has the taxing capabilities of the U.S. government. Consequently, for individuals seeking a guaranteed monthly income, maximizing your Social Security benefit offers larger benefits and more security than income annuities purchased through private insurers.
Does this mean everyone should delay receiving their Social Security benefits? Absolutely not. I believe there are other attractive methods to meet your retirement needs that should be considered. However, for individuals who are uncomfortable watching their retirement accounts fluctuate in value, waiting until age 70 to take Social Security is a viable option.