Income Annuity or Advisory Account in Retirement

Deciding between an annuity or an advisory account can be a difficult choice when it comes to determining how to turn your hard earned and saved retirement accounts into income when you retire. Let's cover the key differences between the two.

Income Annuities: While annuities all have their own bells and whistles, the idea of an income annuity is pretty simple. You purchase a monthly income from an insurance institution for a lump sum. The monthly income will usually be based on the purchase payment, and your age. For *example, an annuity that pays 4% annual income at age 65, might pay 5% at age 67. So if you were to invest $400,000 at age 65 your annual income would be $16,000 annually, but at age 67 would be $20,000. Additionally, if you were to do this at a younger age, there could be a "roll -up" or growth option. For example, if you were to invest your $400,000 at age 55, and wait until age 67, and there is a 4.5% annual income growth rider or benefit, then after 12 years of growth, your income would be based on $678,351.57, instead of $400,000, and at a 5% annual income rate, earn you $33,917 per year in income.

*The examples in this article are hypothetical and for illustrative purposes only. They assume a steady 4 or 5% annual rate of return, which does not represent the return on any actual investment and cannot be guaranteed. Moreover, the examples do not take into account fees and taxes, which would have lowered the final results.

Guarantees are based on the claims-paying ability of issuing Insurance Company.

Pros: 

• An income annuity will pay you for life, regardless of exceeding your principal. In our above example, of $678,351 being invested, paying $33,917 per year, the annuitant would deplete all principal in 20 years, or by age 87, but the insurance company will continue to make those $33,917 annual payments for the lifetime of the annuitant, regardless of if the principal goes to 0.
• No market risk.

Cons:

• Lack of flexibility. With an income annuity, if you take a withdrawal from your principal, you will proportionately decrease your monthly income.
• The growth before collecting income is usually only credited to the income portion of the annuity, not your principal. Meaning when we saw in our sample of $400,000 growing to $678,351, this does not mean if the investor were to cash out the insurance company would write them a check for that balance. That $678k would be the "income benefit base", not the cash surrender value.
• Beneficiaries can receive a much reduced benefit. In out above example where $400,000 would pay $20,000 per year at age 67, if the annuitant were to pass away at age 85, after 18 years of collecting $20,000 per year, the remaining balance for beneficiaries would be reduced to just $40,000.
  
  
• Various potential annuity fees like rider fees and M&E fees.

Advisory Account: When an investor chooses an advisory account, this can be quite different from an annuity. One of the most obvious and often concerning points for investors is market risk. With an advisory account, investors will have an advisor choose investments like mutual funds for the client's account based on that client's individual needs and risk tolerance. The advisor will then often charge a fee for the service, and the account can grow or lose money based on the performance of the selected investments and how those investments change over time. This can also be an income option in retirement. For *example. Let's use our previous example of investing $400,000 at age 65, and then taking income at age 67. Like in an annuity, we now have two different phases. We have a 2 year growth phase, where the investor might want the funds to grow to retirement age at 67, and then at 67 switch to an income phase where the investor wants to see the funds provide an annual income in retirement. Let's say the investor were to earn an average annual rate of return of 7% for the two years leading up to retirement, and then were slightly more conservative and earned an average annual rate of return of 6% in retirement. In the 2 years leading up to retirement the balance would grow to $457,960. Once in retirement, earning 6%, the annual income would be $27,477.60. Providing that the investments continued to average this annual rate of return, the client could withdraw the same amount every year of retirement, without depreciating the initial $457k. This number will vary though based on the client's risk tolerance, goals, investment performance, and advisory fees.

*The examples in this article are hypothetical and for illustrative purposes only. They assume a steady 7% and then 6% annual rate of return, which does not represent the return on any actual investment and cannot be guaranteed. Moreover, the examples do not take into account fees and taxes, which would have lowered the final results.

Past Performance - Investment returns for prior historical periods may not be indicative of future returns. No client should assume that future results will be profitable or directly correspond to the performance results of any comparative benchmark or composite.

Pros: 

• This is a more flexible option than an income annuity. The investor can frequently change how their money is invested, the amount of risk they are willing to take, and how much/often they withdraw money from their account
• There is the potential for higher returns.
• The monthly income is paid from the account balance, rather than premium paid like in an annuity. This offers a potentially greater balance upon death for beneficiaries to receive.

Cons:

• Market risk based on the investments chosen
• Advisory fees

We aren't here to say one option is better than the other, but that investors should consider and understand all of their investment options when it comes to retirement income planning. If you have additional questions about turning your retirement accounts into an income, we are happy to help.