Annuities provide a steady stream of income for retirees in the way that workplace pensions of old once did, protecting retirees from outliving their income. And while Americans weren’t necessarily opting for them after losing access to pensions in preceding decades, these days annuities are getting a second look. That’s in part because of the SECURE Act of 2019, which made it easier for 401(k) plans to offer annuity choices.
Historically annuities have a bad rap. In the days of old (think before IRAs and 401(k)s) the expenses of deferred annuities only made sense because of their limited tax-advantaged options.
While they still carry big fees, Americans are trying once again to navigate the costs and value of annuities in a new era of retirement options.
The value question: Determining whether or not to pursue an annuity really depends on one thing: you.
Not everyone has the same vision of retirement. Maybe you plan to cut expenses when you need to if you live very long, or maybe you want maintain a certain standard of living well past your working years.
Even more, the value of an annuity for a given person ultimately depends on the question of longevity. Individuals or spouses who are healthier and therefore assume longer life expectancy for themselves might anticipate needing to fund more golden years. Still, longevity is an unknown.
Costs vs. benefits on paper: According to a recent economic working paper “Discount Rates, Mortality Projections, and Money’s Worth Calculations for US Individual Annuities,” by James Poterba and Adam Solomon, for annuities purchased immediately at retirement, the value of the annuities was between 92% – 94%, approximately, of its cost. That translates as an insurance protection valuation of approximately 6-8%, a comparatively modest number.
Annuities offer relatively low interest rates. For men aged 65, that interest rate is 2.16%; for women aged 65, 2.18%. This might seem especially low when compared to an average 7% return from the stock market.
The real value: Annuities are expensive with reasonable but not extraordinary payoff. But they offer protection against outliving your assets and a guarantee that you will not run out of money in the way that the stock market and other investments simply can’t. For many, that translates to extraordinary value.