Americans' lack of annuity knowledge hinders retirement income planning, study reveals

An annuity is a financial product that provides a steady income stream, typically used as a retirement strategy. It is an insurance product that you purchase with either a lump sum payment or through a series of payments. In return, the issuer, usually an insurance company, makes periodic payments to you beginning either immediately or at some future date.

Annuities come in various forms, each tailored to different financial needs and goals:

• Immediate annuities. You invest a lump sum amount, and in return, you start receiving payments almost immediately. This type is suitable for retirees who need immediate income.
• Deferred annuities. These allow your money to grow tax-deferred over a period of time before you begin receiving payments. This growth period is known as the accumulation phase, followed by the distribution phase when the payouts start.
• Fixed annuities. These provide regular, guaranteed payments, offering a fixed rate of return. The payments and principal are guaranteed by the insurance company.
• Variable annuities. With variable annuities, payments can vary based on the performance of the investments you choose within the annuity. These are linked to stocks, bonds or mutual funds and thus carry higher risk and potential for higher returns.
• Indexed annuities. These are somewhat a hybrid of fixed and variable annuities. Your returns are tied to a specific market index (like the S&P 500) but you won't lose money if the index performs poorly, although gains are typically capped.

You purchase an annuity by making either a single lump sum payment or a series of payments over time. If you have a deferred annuity, your money grows on a tax-deferred basis until you start making withdrawals. This means you don’t pay taxes on the interest, dividends or capital gains while your investment grows during the accumulation phase.

Depending on the type of annuity, you can opt for payments to begin immediately or at a future date. These payments can be structured in several ways during the distribution phase:

• Life annuity. Provides payments for the remainder of your life, ensuring you do not outlive your resources.
• Fixed period annuity. Payments are made for a specified period.
• Life with period certain annuity. Payments are made for life, but if you die before a certain period expires, the payments will continue to your beneficiary until the period ends.
• Joint and survivor annuity. After your death, your spouse or another beneficiary can continue receiving payments.

Annuities provide income security with a predictable income, which is a significant advantage for retirees. The growth of an annuity investment is tax-deferred, and there are several types of annuities to match different investment preferences and risk tolerances.

However, some annuities can come with high fees, including management fees, insurance charges and surrender charges if you withdraw money early. Also, some annuities, especially variable ones, can be complex and difficult to understand, and fixed annuities might not keep pace with inflation, which could reduce the purchasing power over time.

Determining whether an annuity is a good investment depends on your financial situation, goals and risk tolerance. Annuities can be a beneficial part of a retirement strategy for some individuals, offering a blend of income stability, tax advantages and potential for growth.

So, the purchase of annuity might be a good financial strategy if:

• You are seeking reliable, predictable income for retirement. An annuity can provide a guaranteed income that you cannot outlive, which is particularly valuable if you do not have other sources of fixed income like a pension.
• You have maxed out other retirement savings options. If you have already contributed the maximum to tax-advantaged accounts like IRAs and 401(k)s, an annuity can offer additional tax-deferred growth potential.
• You are concerned about market volatility. Fixed and indexed annuities provide protection against market downturns, which can appeal to more risk-averse investors.

As mentioned, annuities are financial products that can provide a steady stream of income during retirement, helping to bridge the gap between accumulated savings and traditional sources like Social Security. However, the study's findings suggest that many Americans lack a comprehensive understanding of how annuities work and their potential benefits in retirement income planning.

Failing to grasp the role of annuities can lead individuals to overlook valuable opportunities to secure a reliable income stream and mitigate the risk of outliving their savings. Without this knowledge, retirees may struggle to create a well-rounded retirement plan that addresses their unique needs and goals.

The consequences of lacking knowledge about annuities can be severe and far-reaching, potentially derailing an individual's retirement preparedness and financial security. Here's a more detailed look at the potential consequences:

• Underestimating retirement income needs. Without a proper understanding of annuities and their ability to provide a steady stream of income, individuals may underestimate their retirement income needs. This can lead to inadequate savings and a failure to plan for the true cost of living during retirement, which can span decades. Underestimating income needs can result in a significant shortfall, forcing retirees to make difficult lifestyle adjustments or rely heavily on government assistance programs.
• Overlooking longevity risk protection. One of the primary benefits of annuities is their ability to protect against longevity risk – the risk of outliving one's savings. By providing a guaranteed income stream for life, annuities can help ensure that retirees do not run out of money, even if they live longer than expected. Without knowledge of this crucial feature, individuals may overlook strategies to mitigate longevity risk, leaving them vulnerable to the potential of depleting their retirement savings prematurely.
• Missing tax-deferred growth and income benefits. Certain types of annuities, such as fixed and variable annuities, offer tax-deferred growth potential, allowing investments to compound more rapidly than in taxable accounts. Additionally, some annuities provide the opportunity to receive a portion of the income stream as tax-free returns of principal. Lacking an understanding of these benefits can lead individuals to miss out on valuable tax advantages and potential income opportunities.
• Difficulty creating a diversified income portfolio. A well-diversified retirement income portfolio should include a mix of income sources, such as Social Security, personal savings, and potentially annuities. Annuities can provide a reliable, steady stream of income that complements other sources and helps balance risk. Without knowledge of annuities, individuals may struggle to create a truly diversified portfolio, leaving them exposed to market volatility and other risks that could jeopardize their retirement income.
• Increased anxiety and lack of confidence. The study found that individuals with lower retirement income literacy scores experienced increased anxiety and lack of confidence about their ability to achieve a secure retirement. This psychological impact can be significant, leading to stress, worry and potentially poor decision-making. Lack of knowledge about annuities and their potential benefits can contribute to this anxiety, as individuals may feel uncertain about their ability to generate sufficient retirement income.

Addressing this knowledge deficit is crucial to empowering Americans to make informed decisions about their retirement income planning. The study highlights the positive impact of working with a financial professional, as respondents who did so boosted their survey scores by over 11%.

Financial professionals play a vital role in educating clients about the intricacies of annuities and how they can fit into a comprehensive retirement income strategy. By providing tailored guidance and leveraging their expertise, they can help individuals understand the various types of annuities, their pros and cons, and how they can be integrated with other retirement income sources like Social Security and personal savings.

Additionally, educational initiatives and resources from reputable sources can help demystify annuities and promote retirement income literacy among the general public. Efforts to improve financial education and raise awareness about the importance of retirement income planning can empower individuals to make more informed decisions and better prepare for their golden years.

Additionally, educational initiatives and resources from reputable sources can help demystify annuities and promote retirement income literacy among the general public. Efforts to improve financial education and raise awareness about the importance of retirement income planning can empower individuals to make more informed decisions and better prepare for their golden years.