How Annuities Can Help You Retire Early and Delay Social Security

A happy retired couple dance in their living room.

All good financial professionals believe in the value of what they’re selling, whether it’s financial planning, mutual funds or managed accounts. Having sold annuities via my firm’s website for 25 years, I firmly believe well-chosen annuities are a superb tool for saving for retirement and generating guaranteed retirement income.

But belief alone doesn’t mean much unless it is based on facts and analysis. Over the years, several in-depth studies by academics have made strong cases for the value of annuities.

The latest is a 2023 paper, Fixed and Variable Longevity Annuities in Defined Contribution Plans: Optimal Retirement Portfolios Taking Social Security into Account, written by Olivia S. Mitchell, Wharton School professor of business economics and public policy, and Vanya Horneff and Raimond Maurer, Goethe University finance professors.

“For most Americans, it is financially sensible to delay claiming Social Security until age 70, as this maximizes the retirement payments that they receive for the rest of their lives,” Mitchell writes. “Nonetheless, most people do not do this.”

The paper is chock full of equations you’d need advanced math skills to grasp. Fortunately, she has written a reader-friendly summary.

The case for delaying Social Security payments is compelling. If you start taking benefits at 62, you’ll get only 70% of the full monthly amount you’d receive at 66 or 67, depending on whether you were born before 1960. At 70, you’ll get 124% of the full benefit.

Most people would be better off if they had an annuity in their 401(k) account to produce the income that would allow them to defer Social Security payments, the professors write.

Most employees, however, don’t have an annuity option in their 401(k). And many Americans don’t even have a 401(k).

If you don’t have that choice, what can you do if you want to generate income that will let you bridge the gap and retire early without endangering your retirement by taking Social Security benefits prematurely?

Here are some options, which aren’t mutually exclusive. One or more might work for you.

Use nonqualified savings to buy an immediate annuity

Income replacement doesn’t necessarily have to come from tapping a retirement plan if you have substantial savings elsewhere.

A single-premium immediate annuity is bought with a lump sum. Most buyers choose the lifetime income option, but you can instead choose a period certain income annuity that pays out for a certain number of years.

For example, John Doe, age 62, retires and places $200,000 of nonqualified savings in an eight-year period certain immediate annuity and lists his wife as joint annuitant so that she will be protected and continue to receive any remaining payments if he dies before the eight years are up.

He will know exactly how much guaranteed income he’ll get. And he’ll be protected against future declines in interest rates. If he were instead to use a money market fund, he’d get a decent income now but probably much less in the future when rates are likely to be lower.

Based on current rates, as of late April 2024, Joe will receive $2,496.40 per month, including $2,083.33 in nontaxable return of principal and $413.07 of taxable interest. The two will total $239,654.40 over eight years. At 70, the annuity will be exhausted, but then he’ll start collecting Social Security and won’t need the annuity income.

Tapping an IRA to bridge the gap

You may not have enough nonqualified savings to produce enough income to put off taking Social Security benefits. Or you may not want to use those savings. You would then need to tap your qualified plan, such as a 401(k), IRA, Roth IRA or self-employed plan for the funds.

Annuities work well as both traditional and Roth IRAs. At retirement, you can normally transfer funds tax-free from a 401(k) plan to an annuity IRA — a type of traditional IRA funded with an annuity.

You can choose, for instance, an immediate annuity, either the period certain type described above or a lifetime annuity. The former would provide more income over a set period; the latter would guarantee lifetime income.

The advantage is that you can produce ample income, but the disadvantage is that, with a traditional IRA annuity, all the distributions you’d receive are 100% taxable. Nevertheless, for some people, the ability to get much bigger Social Security benefits later on might be worth the tax hit now.

Another good option for an IRA is a “CD-type annuity.” That’s not its official name, but it fits. It’s the insurance industry’s rough equivalent of a bank certificate of deposit (CD) because it pays a set interest rate for anywhere from two to 10 years.

This product, officially the fixed-rate deferred annuity, or multi-year guaranteed annuity (MYGA), pays a robust rate. Depending on how long you’re willing to commit your money, you can (as of late April 2024) guarantee anywhere from 5.45% to 5.96% annually. Nearly all MYGAs let you withdraw interest without penalty, and many let you take out 10% of the balance each year without penalty. You can use the withdrawals to provide income for an early retirement.

A Roth IRA offers tax-free income

The same annuity options are also good choices for a Roth IRA if you have one. Here, there’s a huge advantage: All withdrawals are completely tax-free!

You just have to meet two rules: You must wait until age 59½ before taking money out and wait until you’ve owned the Roth account for at least five years.

While a Roth IRA annuity can produce ample tax-free income, there is a downside. Most people prefer to let their Roth IRA money grow for as long as possible because it’s tax-free forever. But, for some people, it may be worth tapping into a Roth so that you can delay your benefits. Remember, the higher benefits will last for your lifetime.

While delaying Social Security payments is the best choice for most, it isn’t the right choice for everyone. For instance, if you’re in poor health and don’t expect to live to an advanced age, normally it’s wise to start taking benefits as soon as possible.

Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed and lifetime income annuities. He’s a nationally recognized annuity expert and prolific author. A free rate comparison service with interest rates from dozens of insurers is available at www.annuityadvantage.com or by calling (800) 239-0356.