How much of my savings should go to annuities?

Walter Updegrave, senior editor


(MoneyMagazine) -- Question: What portion of my 401(k) and savings should I move to annuities? -- Jack S., Alliance, Ohio.

Answer: That depends. Many annuities have such onerous fees and other drawbacks that you're better off avoiding them altogether.

walter_updegrave__2009b.03.jpg
Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005).

There's one type, though, that I've long believed can play a useful role in some retirement portfolios. I'm talking about immediate income annuities, where you turn over a lump sum to an insurance company and in return receive guaranteed monthly checks for life, regardless of how the economy and markets fare.

But while most people should at least consider devoting some money to such an annuity at retirement, don't assume that buying one is the best move for you.

For one thing, retirees automatically qualify for an immediate annuity of sorts -- Social Security, which provides guaranteed, inflation-adjusted lifetime payments. If you'll be collecting a pension on top of that, you may very well have the assured income you'll need to cover enough of your expected outlays in retirement without an annuity.

What's more, if you have large balances in your 401(k)s and other retirement accounts, you might be able to draw enough from them with little risk of outliving your assets.

Finding the right mix

But if that's not the case, how do you decide how much of your savings should go into an annuity?

There's no one correct answer -- other than you wouldn't want to invest all or nearly all of your savings in an annuity. That's because once you hand over your stash to the insurance company and "annuitize," you typically can't get the money back for emergencies, unexpected expenses, or to pass on to heirs.

One strategy is to devote enough to an annuity so the payments, combined with Social Security and pensions, cover all or most of your essential living costs (like food, utilities, and health care). You can then tap your portfolio to meet discretionary expenses (like travel and entertainment) where there's wiggle room.

Keep in mind that combining annuity payments and draws from your portfolio is likely to give you better odds of sustaining the income you'll need throughout retirement than relying on portfolio withdrawals alone. You can see how different mixes of annuity payments and portfolio withdrawals affect your chances of getting your target income by going to the Retirement Income Planner tool at fidelity.com.

Commit to annuities gradually over time

Early in retirement it's tough to gauge exactly how much guaranteed income you'll need. So even if an annuity makes sense, think about buying in stages. A gradual approach also prevents you from investing all your money in an annuity when interest rates -- and payouts -- are at a low point, as they appear to be now.

Since you'll be depending on the insurer to make those annuity payments throughout retirement, limit yourself to those that get high financial ratings from Standard & Poor's and A.M. Best. And as an extra precaution, spread your annuity money among a few different insurers, and go to nolhga.com to make sure the amount you invest with any firm falls within the coverage limits of your state's insurance guaranty association (typically that's at least $100,000).

One last thing: Most immediate annuities pay you a fixed amount each month, so even if inflation runs a modest 2.5% a year, the purchasing power of those payments will have declined by almost 40% in 20 years. If you want to avoid an income crunch later in life, go with an inflation-adjusted annuity.

You'll have to put in about 35% more for the same initial payment as the fixed-income version, but as Vanguard economist and annuity expert John Ameriks notes, "If you're buying insurance against running short of income, you want it to pay off."  To top of page

Frontline troops push for solar energy
The U.S. Marines are testing renewable energy technologies like solar to reduce costs and casualties associated with fossil fuels. Play
25 Best Places to find rich singles
Looking for Mr. or Ms. Moneybags? Hunt down the perfect mate in these wealthy cities, which are brimming with unattached professionals. More
Fun festivals: Twins to mustard to pirates!
You'll see double in Twinsburg, Ohio, and Ketchup lovers should beware in Middleton, WI. Here's some of the best and strangest town festivals. Play
Overnight Avg Rate Latest Change Last Week
30 yr fixed3.98%3.95%
15 yr fixed3.05%3.05%
5/1 ARM3.32%3.71%
30 yr refi4.05%4.03%
15 yr refi3.12%3.11%
Rate data provided
by Bankrate.com
View rates in your area
 
Find personalized rates:
Index Last Change % Change
Dow 16,805.41 127.51 0.76%
Nasdaq 4,483.72 30.92 0.69%
S&P 500 1,964.58 13.76 0.71%
Treasuries 2.27 -0.00 -0.09%
Data as of 9:13pm ET
Company Price Change % Change
Ford Motor Co 13.78 -0.62 -4.31%
Microsoft Corp 46.13 1.11 2.47%
Apple Inc 105.22 0.39 0.37%
Bank of America Corp... 16.72 0.12 0.72%
Yahoo! Inc 43.50 0.90 2.11%
Data as of Oct 24

Sections

New York headlines took a straight forward and direct approach with NYC's Ebola news. More

The midterm elections are around the corner, and the economy remains a top concern. With unemployment down and inflation low, why do people still feel the economy stinks? More

Shares of Facebook recently topped $80. They've more than quadrupled from their post-IPO lows of two years ago. Can Mark Zuckerberg keep the momentum in mobile going? More

Host a furniture market. Here's how small town High Point, N.C. rakes in this much money -- twice a year. More

If you're looking to fly this holiday season, the clock's ticking to get the best prices. More

Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer.

Morningstar: © 2014 Morningstar, Inc. All Rights Reserved.

Factset: FactSet Research Systems Inc. 2014. All rights reserved.

Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved.

Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor’s Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2014 and/or its affiliates.