How to Retire: All At Once, Or a Little At a Time?

Depending on who you ask, an annuity is either a pragmatic retirement tool, or a black hole.

Many economists and financial planners stand behind the idea that a well-designed annuity is the best way for certain people to manage their retirement. Annuities curb longevity risk — the chance that you will live longer than your income can support you — by spreading and even growing a fixed amount of money over a period of time. However, the short-term interests of those who design annuity programs and the long-term interests of would-be policy holders are often misaligned.

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For example, a fixed annuity is a product where an individual will give some or all of their retirement portfolio to a financial institution that will (theoretically) grow the investment, and kick back a fixed amount to the policyholder. Anything above and beyond that, the institution keeps as payment for a job well done. The obvious risk here is the financial incentive to outperform the fixed payment by tolerating higher and higher risk. If the annuity is not properly insured, or the financial institution is not held appropriately accountable — which is a growing phenomenon given the byzantine nature of regulation — incoming payments could be jeopardized.

In addition to this, retirement products have been shown to have hidden and sometimes enormous costs. Frontline showed in a recent report that administrative, asset management, and marketing fees are often misunderstood by those investing into a 401k. As many as six in ten people are unaware of how much their plans are costing them. Over the course of a lifetime, Americans can pay as much as $109,407 in retirement fees to mutual fund providers.

Unsurprisingly, people have been trying to avoid the worst of each world while getting the best of both. They want their cake, and they want to eat it too — and financial wizards have been all too happy to design products aimed at satisfying this craving.

One example of an increasingly popular retirement product is a 401k plans that includes options to buy insurance annuities. Recently, Prudential Retirement announced that it will distribute IncomeFlex, its variable annuity, to more than 3,000 workplace 401K plans administered by Walls Fargo Prudential.

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The payout of a variable annuity is in the name, but most good plans will have a minimum withdrawal feature. Either annuity option — fixed or variable — provides a payout based on the initial amount invested, current market conditions, and how soon you want the funds. In Prudential’s case, you can invest in a portfolio of stocks and bonds for up to 10 years prior to retirement. Payments will increase if the portfolio beats pre-established benchmarks.

It’s common knowledge that if you want to retire as comfortably as possible, you should begin saving as early as possible. However, purchasing annuities within a 401k prematurely can be costly. Annual insurance costs mean that it only really makes sense for people who will retire in about 10 years to begin annuitizing their 401ks.

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