Retirement today requires more planning than in previous generations. Sources
of steady retirement income have changed, as fewer and fewer workers are
covered by traditional employer-provided pensions that provide a lifetime benefit.
In addition, advances in medicine have resulted in increased longevity—today’s
retirees may spend 20, 30 or more years in retirement.
Given this landscape, workers nearing retirement face an imminent crisis:
how to generate a stream of income that is guaranteed to last throughout
retirement. Whether they have access to employment-based retirement plans
or not, achieving stable and secure income in retirement is a challenge for many
Americans.
With the decline of defined benefit plans and increased popularity of defined
contribution plans, such as 401(k)s, responsibility for managing retirement savings
has shifted from the employer to the individual. Unlike traditional pensions that
provide a stream of payments to retirees for life, defined contribution plans
typically offer a lump sum that retirees must then manage on their own.
Other than Social Security and the defined benefit system, the only means to
create a guaranteed income stream in retirement is through an annuity. An annuity
is an insurance contract that offers an efficient solution to what otherwise could
be an overwhelming asset management task: creating a steady paycheck in
retirement that cannot be outlived. It helps to ensure retirees don’t overspend and
run out of money in retirement and that they don’t live too frugally either.
Individuals without access to workplace retirement savings plans have an even
greater challenge: to independently accumulate savings during their working years
and manage those savings to last throughout retirement. An annuity can address
both of those needs.
SUCCESS OF THE PRODUCT
Annuities offer solutions to both sides of the retirement equation: They provide
ways to accumulate retirement savings and to turn savings into an income stream
that cannot be outlived.
The lifetime income option through annuitization allows retirees (and their
spouses) to maximize retirement income without having to worry about payments
stopping while they are alive. At the time of purchase, annuity owners are
guaranteed that if they choose to annuitize at a later date, they will receive
a benefit based on the purchase rates at the time the annuity was issued or
annuitized—whichever rate is more favorable to the annuity owner. Given the
changes that can occur over time with respect to the economy, longevity, or an
insurer’s costs, this is a valuable consumer benefit.
Many insurers offer additional annuity options-—such as the guaranteed minimum
withdrawal benefit—which allow consumers to create and manage income flow
to meet various income needs as they age while still offering guaranteed income
for life. Other income options, which do not have a lifetime guarantee, also are
available.
CURRENT TAX TREATMENT
By encouraging long-term savings during the working years and helping individuals
manage assets during retirement, the current tax treatment of annuities promotes
financial discipline.
For those who are years away from retirement, or are retired and have assets
that don’t need to produce income right away, a deferred annuity allows savings
to build up, free of current federal income tax. When payments are received, the
portion that comes from earnings is taxed as ordinary income.
To encourage long-term savings for retirement, there are tax penalties for
withdrawals from deferred annuities before age 59½ in addition to the income tax
due on earnings. The tax penalty is not applied to certain lifetime payouts, death
benefits, or payments made if an annuitant becomes disabled. Other exceptions
may apply.
The current tax treatment has served as an effective savings incentive: 77 percent
of individual annuity owners report that they have set aside more for retirement
than they would have if the tax-deferred growth of annuities was not available.
A large majority cite the tax treatment of annuities as a “very” or “somewhat”
important reason for their purchase.
The current federal income tax treatment of annuities is reflective of sound public
policy that recognizes the annuity’s unique role in helping Americans accumulate
savings for retirement and guarantee a steady stream of income for life.
CONCLUSION
An annuity can help American workers meet the challenges of the changing
landscape of retirement. In fact, eight out of 10 individual annuity owners say
they will use their annuity savings for retirement income.3 With the shift from
defined benefit to defined contribution plans and increased longevity, the role of
the annuity in retirement has never been more important. Policy-makers should
explore ways to encourage more Americans to turn to annuities for long-term
savings and guaranteed lifetime income.
