How Much Do You Need To Save For Retirement To Buy An Annuity That Yields Enough Income For You?

Take a look at your 401(k) statement. Does it have a number that suggests what your projected retirement income will be? It should. The SECURE Act requires this.

What you’re seeing is an estimation of what you’d receive today, based on your current retirement plan balance and assuming you are 67 years old. In effect, it reflects the amount you’d receive should you use your entire retirement assets to purchase an annuity.

There are a number of factors that have increased the interest in annuities, an insurance product that promises to pay you a monthly sum for the rest of your life. The appearance of this lifetime income estimate may be one of them, but there are others.

“The demand for placing annuities into retirement plans like 401(k) plans is coming from future retirees’ worries about volatility in the stock market,” says Clark Kendall, President & CEO of Kendall Capital Management in Montgomery, Maryland. “Many people want guaranteed income for the rest of their lives without the risks that come with investing in the stock market.”

It’s not just worries, though. The allure of the concept of an annuity also derives from the familiarity of the routine people are used to.

“American workers are gravitating toward the idea of receiving guaranteed lifetime income throughout their retirements because they like the idea of still receiving monthly checks without having to work,” says Ryan D. Brown, Partner and Attorney at CR Myers & Associates in Southfield, Michigan. “Most Americans get paid every two weeks for 30+ years, and then one day they retire and that stops. Continuing that throughout retirement requires an annuity because it is the only financial product in the world that can accomplish that.”

Despite this interest, there remains some amount of trepidation regarding the purchase of annuities. You can understand why. The future is uncertain, and with annuities you are counting on things staying the same. As we’re seeing right now with the spike in prices, that might not be a good assumption.

“One of the major hesitations for placing annuities into retirement plans like 401(k) plans is annuities’ inability to hedge against inflation,” says Kendall. “If your plan includes a 10-year fixed-rate annuity with an interest rate of 3.25% and inflation is at 7%, you are losing 3.75% of purchasing power. Yes, you still have guaranteed income coming in, but locking yourself into a fixed income will leave you with less purchasing power as inflation rises.”

Today, the impact of inflation may have the feel of a short-term aberration, albeit primarily because it has been a long time since many have experienced it. Indeed, if you’re a late Gen-Xer or Millennial, you might never have experienced long-term inflation. Is this concern justified or are you just anxious because you’ve never experienced it before?

“Participant hesitation about placing their retirement assets in annuities is valid,” says Kendall. “From gas to grocery prices and now with the war on Ukraine, we are seeing inflation continue to rise. I understand why people use annuities. Generally, people worry that they will not have enough money to last if they live to be 90+. The real risk with annuities is if you are guaranteed $1,000 a month, that $1,000 might not be worth the same when you are 110 as it is worth today.”

Inflation, however, isn’t the only cause of anxiety regarding annuities. These products tend to be complex. It’s often difficult for you to wrap your head around both the fees associated with them and the benefits offered by them.

“Another major hesitation for placing annuities into retirement plans is the extra cost that comes with them,” says Kendall. “Because annuities are insured, companies and/or individuals have to pay insurance fees that they would not have to pay for traditional mutual funds. The insurance does add another layer of protection for your hard-earned money, but it comes at a cost. For those who do not want to risk anything and do not want to go through the trouble of figuring out other ways to invest in their futures, this added cost might be worth it. For those who have a financial advisor to manage their retirement, it is probably best to invest in mutual funds rather than annuities.”

This brings you back to that projected monthly income number on your 401(k) statement. How reliable is it? Should you risk making any significant financial decisions based on it?

“The ‘Monthly projected income’ on your 401(k) statement could be misleading because it is guessing future income based on today’s market,” says Kendall. “Your projected income depends on multiple variables including inflation and interest rates. Companies that provide 401(k) accounts use different data points and discount rates to reach investors’ projected incomes, so the projected incomes are not guaranteed. If you do not know much about investing and market volatility, you could be misled by the projection.”

Here’s the real problem. Although it might be understood that your 401(k) statement is just an estimate, even when converted to a real annuity it does not make the promise of the benefit as certain as you might think.

“The word ‘projected’ can be a problem since you may assume that’s a guarantee,” says Anthony C. Kure, Managing Director of Northeastern Ohio Market at Principal Wealth Management in Cleveland. “In the case of annuities, nothing is guaranteed. If an insurance company goes out of business because they were selling high-payout annuities and could not make good on those payments, then the annuitant can be left holding the bag. There are no guarantees. This concept is usually buried in the fine print in what could be a contract consisting of a two-inch stack of documents.”

There’s still one more issue you might be overlooking. For all the comfort a steady stream of monthly income annuities provide, do you know how much money you need to purchase an annuity that provides the level of income you need to retire in comfort?

Unfortunately, this isn’t an easy question to answer. “Given the wide array of variables that are part of any annuity, it’s impossible to answer this question accurately,” says Kure.

“The current monthly income for annuities largely depends on the age of the annuity holder,” says Kendall. “For example, if a 40-year-old wants their annuity income to stretch throughout their lifetime, their monthly payment would be lower than the income of a 65-year-old.”

To give you a sense of what to expect, Dave Hanzlik, Vice President, Annuity and Retirement Solutions, CUNA Mutual Group, in Madison, Wisconsin, provides a useful example, provided you make yourself aware of the limitations. “There are a lot of factors that can impact an annuity payout, including age, gender and legacy for beneficiaries,” he says. “The following information applies to a 65-year-old electing a cash refund death benefit (premium less the sum of all payments made) and is an average for males and females. It provides both the total cost of the annuity and its monthly payout:

• $100,000: $440 monthly
• $400,000: $1,760 monthly
• $1,000,000: $4,400 monthly”

While it is possible to show an example based on current market rates, remember, the current figures constantly change. If you want to know what you can get for an annuity, you’ll need to speak to a specialist.

“Annuities aren’t for everyone,” says Dallas-based Mark S. Gardner, president of Retire Well Dallas. “However, if the contractual guarantees can help fill gaps in your plan, you might consider an annuity for your situation. In addition, should you want to accumulate more money for your retirement income, annuities can also be an excellent complement to retirement accounts and other savings vehicles.”