Behavioural issues to consider when investing in retirement
Interesting research by the U.S. National Institute on Aging and the Social Security Administration found the actual amount people spend in retirement is only loosely related to retirement savings. The gap in wealth of different retirees was not found to reflect proportionate differences in spending and it was hypothesized people have a difficult time spending money out of their nest egg. People find it much easier to spend money from income, such as the guaranteed payout from an annuity.
Annuities guarantee you a stream of income in exchange for your assets and cannot be changed once selected. Annuities can be fixed or linked to inflation and can also be set up with various payout guarantees in the event of death. The security of annuities does, however, come at a cost. Annuities are designed to factor in a profit for the insurance company. Your upfront payment to the insurance company will be mostly invested in bonds. Since interest rates have been declining since the early 1980s, the interest yielded by bonds are at multi-decade lows and therefore, the payout ratio offered on annuities by insurance companies are also low from a historical context. Many would argue that investing your money, rather than buying an annuity, is the smart choice from a financial perspective.
While a retiree may make more money by investing their retirement nest egg, the fear of future losses from the ups and downs of financial markets may make them avoid spending more. For this reason, you may consider buying annuities with a portion of your savings.
It is recommended that you speak with a qualified financial advisor when deciding on how to best generate income for your retirement, considering your specific circumstances.