Social Security was only designed to help with 40% of your retirement - but think twice before choosing an annuity

By Beth Pinsker

Guaranteed income can be a tricky concept in retirement planning

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Dear Fix My Portfolio,

I just read your article about Christine Benz's book "How to Retire." You mention that Benz talked about her own planning and included Social Security as well as consideration of an annuity.

I am in my 70s and retired, so I have been thinking about retirement for a long time. My view is that Social Security is akin to an annuity, plus it has an annual cost-of-living adjustment. As a result, if you have a healthy Social Security monthly payment, there's no need for an annuity. Does a retirement spending plan really need to include an annuity?

Enough's Enough

Dear Enough's Enough,

Guaranteed income is a tricky concept in retirement planning. There's no right answer that fits everyone.

You are correct that Social Security is an annuity, and a very good one that increases the payment each year to keep up with inflation. This year's increase is likely to be 2.5%, but the past few years have seen big increases because of the rise of the cost of living in the U.S. The catch with Social Security is that it was only designed to replace about 40% of a worker's income at retirement.

Where's the rest supposed to come from? Pensions, savings, social services and family usually fill in the rest. The reason people turn to annuities is because they want more of what they get with Social Security: guaranteed income each month that will keep coming as long as they live.

Pensions are good for this kind of income replacement, but they are few and far between these days. And some pension payments turn out to be much smaller than people expect, either because the pension fund was not able to keep its promises or because the payout was not designed to be adjusted for inflation.

Social Security was only designed to replace about 40% of a worker's income at retirement.

Some people turn to their savings and try to think of ways to turn a lump sum into a monthly stream of income that is guaranteed for life, and for that, you need an annuity. You also need quite a bit of savings. For a monthly annuity payout of any significance, you need to buy into it with a lump sum and then an insurance company will pay you back at a steady clip with interest.

The simplest way to do this is with what's called a single-premium immediate annuity (SPIA), which takes your lump sum and immediately turns it around into a monthly payment. For a 70-year-old woman living in New York, it would take about $172,000 to get $1,000 a month for just that person's lifetime, with no bells and whistles like a guaranteed payment timeline even if you die soon after buying or survivor benefits, according to a calculator from USAA.

There are many flavors of annuities, each more complicated than the next. They aren't right for everyone and they all come at a cost.

"I'm not a fan because there can be a lot of fees," said Marti Awad, a certified financial planner based in Colorado. "They are more attractive to the person selling them rather than the person getting them."

For most Americans, this isn't even a choice. They simply don't have the means to buy into a private annuity of any kind. As many as 40% of seniors have no savings, so that monthly Social Security check is all they have. They find ways to make it work, or they lean on social services or family.

Another big chunk of the population has a small amount of savings beyond Social Security, and they spend that as they go. The median retirement savings of those aged 64-74 was only $200,000 in 2022, according to the Federal Reserve. That doesn't leave enough room to spend all of it on an annuity that nets out at just $1,000 a month, and likely doesn't come with inflation-adjustment at that price. You wouldn't want to put all your eggs in one basket of an annuity and have nothing left over for emergencies.

When an annuity makes sense

An annuity beyond Social Security and a pension would only come into your plan if you have enough savings and if you want guaranteed income that covers the 60% of expenses that Social Security doesn't cover.

You might, for instance, have longevity genes in your family and expect to live a very long life so you want to stretch your savings as far as you can. You might be very cautious and want to know you have money coming in to pay your bills - it can be hard after a lifetime of earning to do without a steady paycheck. You might be very bad at managing money and just want something steady and safe. You might also want to mitigate your tax bill.

"An annuity can make sense if people want more tax-sheltered investment," said Awad - if you can get a very stripped down annuity that has low fees, she adds. The money you put into an annuity like this is typically tax-deferred until you withdraw it, and then it is taxed as income.

Another thing to know about annuities is that they will not grow like stocks, or in conjunction with the stock market. These are an insurance product, not an investment, and fees will eat into your eventual overall return. That is a valid choice - insurance is for security, and some people need and want that in retirement - but it's not for everyone.

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-Beth Pinsker

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10-08-24 1324ET

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