Last Sunday, a conversation came up on retirement as we were having family lunch. As you may have guessed, the conversation elicited a lot of opinions from when we should start having a solid retirement plan to the preferred choices of retirement plans.
According to several financial advisors, the best time to start saving for retirement was yesterday, a statement that holds true. However, the big question is: What should this retirement plan look like? Is it a real estate investment? Is it a farming business? Is it purchasing an annuity?
In most of our African settings, a typical “retirement plan” is structured as; parents use almost all their earnings during their working ages to educate their children resulting in little to no savings at all. Then the children are responsible for meeting their parents’ needs when the parents retire. The cycle continues from a generation to the next and the question of whether this arrangement is sustainable is a topic for another discussion.
Today we explore the different reasons why you should consider taking annuities, particularly fixed annuities. as a retirement plan.
What is a Fixed Annuity?
An annuity is a form of financial agreement between an individual and an insurance company such that the individual receives a series of payments for a period of time, based on the survival of the individual in exchange for a lumpsum payment. An annuitant is a person who takes an annuity contract. There are various types of annuities, including immediate annuities, deferred annuities, fixed annuities and variable annuities. For this discussion, my focus will be specifically on fixed annuities.
A fixed annuity as the name suggests provides guaranteed streams of income to the annuitant; So, in the case of retirement, a retiree pays a lumpsum amount of money to an insurance company and receives regular payments for life or in some cases for a specified period , such as 10 years or 20 years.
Why a Fixed Annuity in Retirement?
Income predictability is a key aspect that a retiree would be interested in since the retiree has been receiving a salary that was also predictable in their working age. Fixed annuities provide this since the amounts of payments are certain.
Fixed annuities that offer income for the duration of the annuitant’s life are beneficial to retirees such that the guaranteed income reduces the risk of retirement poverty and ensures financial stability throughout retirement.
Above and beyond the promise of a guaranteed income, tax-deferment is also something that the retiree will benefit from taking a fixed annuity because they will not pay taxes on the income earned up until the point of withdrawal.
Lastly, fixed annuities that offer the payments in regular time intervals, such as monthly or annually will enable the retiree calculate their income replacement ratio (IRR). The IRR helps the retiree know how much their retirement income will replace their pre-retirement income. In this case, the ratio will give the retiree an idea whether the annuity income will sustain their needs in their retirement.
Caution to be taken before you invest in a Fixed Annuity.
Despite the benefits that come with investing in a fixed annuity, a retiree should take caution of the following to prevent them from blowing their lifetime savings.
The financial condition of the life issuer is a key consideration because neglecting to evaluate it might result in the retiree taking an annuity from an issuer who is facing bankruptcy, hence end up losing their savings.
Although fixed annuities are low risk, the retiree should also consider their risk tolerance in consultation with their financial advisor to determine their risk appetite levels.
Finally, a retiree should be aware of the inflation risk that comes with fixed annuity payments such that the continuously rising prices of goods and services can decrease the purchasing power of the fixed annuity streams of income.
By considering these factors and in consultation with their financial advisors, retirees will ensure that their chosen retirement plan i.e. investing in fixed annuities, will support their financial security and goals.
First Published on Business Daily.
Article by Mercy Kimunge
