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Why you may need an annuity now more than ever

AgeUpLongevity, Money

As anyone who scans the financial news will know, the stock market can be volatile. In the Panic of 1907, the value of the New York Stock Exchange dropped by 50%. In the three years after the Wall Street Crash of 1929, the Dow Jones Industrial Average lost 89% of its value. On Black Monday in 1987, the Dow dropped 31% in a single day. And in the Great Recession of 2007-2009, the Dow lost over half its value.

The Great Recession is especially relevant to those nearing retirement today. American IRAs and 401(k)s lost about $2.4 trillion in the second half of 2008. For perspective, that’s enough to buy out all of the U.S. cash in circulation, plus an additional $1,600 for every single person in the country. Baby boomers were hit especially hard: according to U.S. News & World Report, the average diversified stock fund fell 38% in 2008, and boomers with 20+ years on the job lost a quarter of their retirement funds.

The average diversified stock fund fell 38% in 2008, and boomers with 20+ years on the job lost a quarter of their retirement funds.U.S. News & World Report

More recently, the Dow had its largest daily point drop in history on March 16, 2020, following the COVID-19 pandemic. Thankfully, things have rebounded somewhat since then, but the Dow’s 710-point drop on June 23 is another reminder of just how turbulent the market can be.

If history is any indication, the long-term outlook tends to be positive, but past performance is no guarantee of future results. It’s also small consolation to people whose retirement coincides with a crash.

On that last point, New School economics professor Teresa Ghilarducci found in a 2015 article in The Atlantic that boomers’ retirement funds never fully recovered from the Great Recession. As the article notes, when your investments take a significant hit, recovering the value can be a very steep climb. If you have $10,000 and the value is cut in half, you’ll have $5,000. But a 50% increase would only get you to $7,500. Getting back to even after a 50% loss requires a 100% gain.

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How annuities can help

Partially due to the 2008 crisis and recent market swings, a large number of baby boomers are entering retirement with smaller nest eggs than they’d like. Life expectancies are also longer than previous generations, and pensions have largely disappeared from the private sector. That’s not an ideal combination, but there is a potential solution.

Many income annuities pay a guaranteed stream of income for life, guarding against the risk of outliving one’s savings. They’re also shielded from the market risk that set back so many of today’s retirees. Yet despite the obvious upside, income annuities aren’t as popular as many economists think they should be. There’s even a term for it: the “annuity puzzle.”

Social Security and pensions are both essentially large-scale versions of income annuities, and are popular with the public at large, but few consumers choose to annuitize even a portion of their savings at retirement. Why is that?

According to Wharton Professor Olivia Mitchell, solving the annuity puzzle may be a matter of reframing how consumers think about annuities. Rather than an investment, it may help to think of annuities as a form of protection. In a Q&A published by Wharton, Professor Mitchell said:

“People don’t want to buy a lifetime annuity and then worry about being hit by a bus the moment they leave the insurance office because then they’ll say, ‘Oh, all my money went for naught.’ Of course, that’s the way that insurance is supposed to work. If your house doesn’t burn down, you don’t get any money from the insurance company. You were protected. But I think people don’t really understand insurance, and annuities are a component of that.”

“If your house doesn’t burn down, you don’t get any money from the insurance company. You were protected. But I think people don’t really understand insurance, and annuities are a component of that.”Olivia Mitchell, Wharton Professor of Business Economics and Public Policy

An annuity for later

Deferred income annuities, or DIAs, are similar to immediate annuities, but with a deferral period before income payments start. Because of the waiting period, DIA payouts are larger than typical income annuities, dollar for dollar. That’s because the insurance company has more time to generate the returns they use to fund payouts, and because those payouts last for a shorter period of time.

In her analysis, Professor Mitchell found that putting between 5-15% of a retirement nest egg into a deferred income annuity that begins paying out at 85 can substantially improve a retiree’s well-being. How? According to her, by setting aside that portion as a hedge against outliving their savings, retirees can spend (and breathe) a little easier early in retirement.

Setting aside 5-15% of a retirement nest egg into a deferred income annuity as a hedge against outliving their savings can help retirees spend a little easier early in retirement.

A new DIA

Most deferred income annuities are purchased with a one-time payment. For typical DIAs, there’s a minimum of $10,000, and the average premium is much, much higher. They’re also not liquid assets. Once the purchase is made, the money isn’t accessible until the deferral period is over (or death, if you choose a DIA with a premium return option.)

Setting aside a significant portion of your savings is fine for those who can afford to pay a lump sum, but what about those who can’t? That’s the problem AgeUp was created to solve.

Rather than a one-time payment, AgeUp is purchased in monthly increments starting at $25. The monthly purchase payments can be adjusted or paused if money is tight, then resumed or increased when finances improve.

AgeUp payouts also start later than most deferred income annuities, beginning at any age you choose between 91 and 100. Age 91 or later may seem high, but the chances of living that long are better than you may think. According to the Longevity Illustrator from the Society of Actuaries, a 65-year-old woman in average health has a 44% chance of living to 90 or beyond. For a man in average health, that number is 33%. Even living to 95 isn’t that unlikely, with chances of 23% and 15%, respectively.

The longer deferral period allows the monthly payouts to be much larger than typical DIAs, dollar for dollar. If you’re concerned about the advanced age, you can choose to have your premiums returned to a beneficiary if you die before AgeUp payouts begin. Choosing the premium return option will reduce the size of your payouts if you do live to your target payout age, but it eliminates the risk of losing your premium payments if you die before then.

Setting aside a small monthly premium with large relative payouts can serve as a hedge against the higher living and medical expenses that often come with advanced age. For anyone at or nearing retirement age, an affordable DIA like AgeUp may be worth considering to help round out retirement plans.

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