When to say yes to an annuity -- and when to pass

Biggest retirement mistakes
Biggest retirement mistakes

One financial adviser has recommended that I buy an annuity, but another says I shouldn't. How can I tell whose advice I should follow? --R.H.

It's not uncommon for different financial advisers to have different takes on what investments make the most sense for your retirement portfolio. But I've found that diametrically opposed recommendations are especially common when it comes to annuities.

Many advisers seem to see annuities as the solution to almost every problem; others appear vehemently opposed to recommending them under any circumstances. Not surprisingly, the gung-ho annuity group tends to reap much of its compensation from commissions and other perks from annuity sales, while the never-annuity advisers generally make their living from the annual management fees you pay them if you invest your savings with them rather than buy an annuity.

Which, unfortunately, leaves you -- and others like you who might wonder whether an annuity should be part of their retirement portfolio -- in the middle, unsure whose advice to follow.

I don't know enough about your financial circumstances to be able to side with either one of your opposing financial advisers. And even if I did, there may be compelling non-financial reasons you might be a candidate for an annuity. What I can do, however, is lay out some guidelines to help you decide whether, given your particular situation and needs, an annuity is right for you.

Before I do that, though, I want to make it clear that while there are many different kinds of annuities out there, I believe that one type stands out when it comes to delivering retirement income you can count on throughout retirement no matter how long you live: immediate annuities. They're also easier to understand than most other annuities, many of which can be mind-numbingly complicated.

Related: Buy an annuity now or wait for interest rates to rise?

The premise behind an immediate annuity is pretty easy to grasp. You hand over a lump sum to an insurer and in return you get a monthly payment guaranteed to last as long as you live (or, if you wish, as long as you and a spouse or partner are alive). You can see how much guaranteed income an immediate annuity might generate today given your age and how much you have to invest by going to this annuity payment calculator.

Which brings us to the first question you should ask yourself to determine whether you're a candidate for an annuity -- namely, do you think you'll need more guaranteed income than you'll already receive from Social Security and any pensions you may be eligible for? If the combination of your Social Security benefit plus pension income falls short of what you'll need to pay most or all of your essential living expenses in retirement -- which you can estimate by using a tool like BlackRock's Retirement Expense Worksheet -- then you may want to bridge that gap by devoting a portion of your nest egg to an immediate annuity.

If, on the other hand, assured income sources like Social Security and pensions will likely cover all or most of your essential expenses, then an annuity might be superfluous. Chances are you can live comfortably enough by simply supplementing the guaranteed income you'll already be receiving from Social Security and pensions with periodic withdrawals from your retirement savings.

For that matter, even if Social Security and pension income, if any, isn't enough to cover your essential living expenses, you may still be able to get by perfectly well without an annuity if your nest egg is large enough that your chances of running through it during your lifetime are minimal. You can gauge your chances of depleting your savings during the number of years you'll likely live in retirement by going to this retirement income calculator.

Annuity payments: Income for life

That said, there could be other reasons you may find an annuity's assured income appealing. Knowing that you'll collect guaranteed lifetime payments regardless of what's going on in the stock or bond markets may allow you to feel more comfortable about investing the rest of your savings in an appropriate mix of stocks and bonds -- and more apt to stick with your strategy during times of financial duress.

And research shows that people who receive guaranteed income from a pension or annuity also tend to be happier in retirement. For example, a 2015 TIAA-CREF Institute study found that retirees who converted at least some of their retirement savings into annuity payments were more likely to say their standard of living improved after retiring and that their retirement lifestyle exceeded their expectations.

Ultimately, though, I think it makes little sense to buy an annuity unless you feel pretty damn sure that putting a portion of your retirement savings into one is the right move for you. Learning more about the pros and cons of annuities and how they work, knowing which questions to ask of advisers touting them and understanding how to choose the right one can give you more insight for making the decision of whether to "annuitize" some of your savings. But unless (or until) you're convinced that an annuity will provide some benefit you really need and that you can't otherwise get, my advice is to pass.

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