Actionable Strategies for Choosing the Right Path
The choice between annuities and investments is not one-size-fits-all. It is a deeply personal decision that depends on your unique financial situation, goals, and comfort level with risk. Here are the key factors to consider to build a strategy that works for you.
1. Assess Your Income Needs and Existing Resources
Start with the basics. How much money do you need each month to live comfortably? Make a detailed budget that covers all your essential expenses (housing, food, healthcare, utilities) and your discretionary spending (travel, hobbies). Now, add up all your existing sources of guaranteed income, such as Social Security and any pensions you may have. The difference between your total expenses and your guaranteed income is your “income gap.”
Example: Let’s say your monthly expenses are $4,000. Your Social Security benefit is $2,200, and your spouse’s is $1,300, for a total of $3,500. Your income gap is $500 per month. The primary question becomes: how will you reliably generate that extra $500?
If your top priority is to fill that gap with a 100% predictable source, an annuity could be an excellent solution. You could use a portion of your savings to purchase an immediate annuity that pays you exactly $500 a month for life. If you have no income gap or prefer more flexibility, you might use investments to generate that income instead.
2. Be Honest About Your Risk Tolerance
This is perhaps the most important emotional component of the decision. How do you feel when you see the stock market go down? Does it cause you to lose sleep, or do you see it as a normal part of a long-term cycle? An annuity is designed for those with a low tolerance for risk. Its main selling point is peace of mind. You are trading potential market growth for a guarantee.
Investments, on the other hand, require you to accept a certain level of risk and volatility. Even a conservative portfolio of bonds and dividend-paying stocks will fluctuate in value. If you can handle these ups and downs and have a long enough time horizon, investing offers a greater chance to grow your wealth and keep pace with inflation.
3. Consider the Power of a Hybrid Approach
For many seniors, the best strategy is not “either/or” but “both/and.” You can use an annuity to build a solid income floor and use investments for growth and flexibility. This is a popular and practical approach to senior finance.
Example: Imagine you have retired with $600,000 in savings. Your essential monthly expenses are covered by Social Security, but you need an additional $1,500 per month for travel, healthcare co-pays, and other variable costs.
You could allocate $300,000 of your savings to purchase a fixed immediate annuity. This might generate approximately $1,500 per month for life, creating a reliable income floor that guarantees your lifestyle needs are met. The remaining $300,000 can stay invested in a diversified portfolio of low-cost mutual funds. This portion is for growth, to help combat inflation, cover unexpected large expenses (like a new roof), and potentially serve as a legacy for your children or grandchildren.
4. Factor in Inflation and Your Legacy Goals
Inflation is the silent wealth-killer in retirement. A fixed monthly payment that seems adequate today may feel much smaller in 10 or 20 years. A simple fixed annuity does not protect against this. While you can buy inflation-protection riders for some annuities, they are expensive and will reduce your initial payout. Historically, a diversified portfolio of stocks and bonds has been one of the most effective ways to outpace inflation over the long term.
Also, consider what you want to happen to your money when you pass away. Money in investment accounts can be easily passed on to heirs. With annuities, the rules can be more complex. Many basic life-only annuities stop paying out upon your death, with nothing left for your family. You can purchase options (like a “period certain” or “joint-and-survivor” annuity) that provide a death benefit, but again, these features will lower your monthly payments.
This section is part of our comprehensive guide to senior finance and retirement income strategies.
