These days, annuity is a common word heard in discussions about retirement. Yet many people don’t know what an annuity payment is or how to use it. People who do know worry that annuities will further limit their fixed incomes, while others are afraid they can’t afford an annuity at all.
What Are Annuities?
Annuities are insurance contracts that guarantee your retirement money won’t run out. With an annuity, you can have a steady stream of income for the rest of your life – if you’re willing to pay for it.
There are many different types of annuities, all with different riders, disclaimers, and contingencies. Maneuvering through annuities is therefore very difficult, and generally requires the assistance of a financial professional. There are two basic types of annuities:
● Immediate annuities. If you need income right away, because you suddenly find yourself without income, you can convert a lump sum into an annuity that will immediately pay you.
● Deferred annuities. If you don’t need a steady stream of money right away, you can choose to defer your annuity and receive payments at a later date of your choosing. Until you’re ready to take the money, it will grow tax-free, just like a 401(k).
To begin paying for an annuity, you’ll need to purchase a contract and pay a premium through your insurance carrier. You don’t necessarily have to be the contract owner, in the event you prefer someone else to be the owner (such as a spouse). Ownership can be shared between two or more people.
Once you’ve purchased your annuity, you can decide if you need immediate payments or if you want to receive your payments later. From there, your annuity becomes a long-term investment that helps you accumulate assets and protects you from outliving your income. This provides lasting peace-of-mind for many retirees who are unsure how long their retirement fund will last.
Benefits of Annuities
Annuities come with many benefits, not the least of which is providing permanent peace of mind for the duration of your life. Other benefits include:
● Large amounts of money stored without being taxed
● No annual contribution limit (you can put away as much money as you want)
● Money you invest compounds year after year with no tax bill
● You can choose one lump-sum annuity payment or set up monthly payments
● No income phase out schedules for contract owners
● Guaranteed payout, even if the value of the contract is completely exhausted
● Freedom from creditors and probate proceedings
● Exemption from FAFSA assets (leading to greater loan eligibility)
The main pull to sign up for an annuity is the guarantee of financial stability on a steady basis, for the rest of your life, without risk of it ever running out. This is especially important for the baby boomer generation just now hitting retirement and falling woefully short of retirement fund goals.
Another benefit of annuities is that your loved ones will receive monthly payments for the duration of their lives if you die before you start receiving payments. Your named beneficiary will receive a specific payment monthly, quarterly, or annually depending on your contract, providing them with a safety net after your death.
During the payout phase, not only do you receive the payments you’ve made back, but you also get any investment income and gains that have been made on your payments. This makes annuities more appealing to some people than 401(k) plans or IRAs, which don’t offer additional tax advantages.
Costs Associated With Annuities
An annuity could be the saving grace of your retirement, or it could result in exorbitant charges and fees. The cons of an annuity can include risks such as:
● Your insurance company going out of business during your payout phase
● Substantial taxes and charges
● Penalties if you withdraw your money early
● Investment risks connected to the current market
Many people decide that annuities aren’t worth the costs and risks, especially since Social Security more or less provides the same sense of long-term financial stability to retired people. Annuities always involve a plethora of different fees, not all of which are made known at the time of purchase.
Fees include, but are not limited to mortality and expense risk fee (typically 1.25%), annual contract fee (typically 0.15%), investment management fees, rider fees, commissions (between 1% and 10%), and withdrawal charges that can amount to major portions of your money lost forever.
To ensure your money will last, you can opt for a low-cost immediate annuity that will cover fixed retirement costs, or pair a fixed annuity with stocks or bonds to maximize your potential returns. The costs of annuities are often worth it to those who have already maxed out all of their other tax advantage accounts.
If you are in a high tax bracket based on your income, you could benefit from setting your money aside in a tax-deferred annuity instead of a mutual fund, which you have to pay taxes on every year. Also, if your job doesn’t offer a pension, an annuity can fill this gap in your monthly retirement income.
Do What’s Right for You
An annuity is a very complex insurance product that most people cannot easily navigate. If you’re considering an annuity, you’ll most likely need to hire a professional financial advisor. There are many kinds of annuities, and you’re free to choose the one that best fits your lifestyle. It’s up to you whether you think an annuity is the right path for your retirement – just weigh all the facts before jumping into an annuity agreement unprepared.
Before you sign any contracts or buy any financial products, you should ask questions and seek council from a third party. Make sure you or a hired professional does plenty of research into the annuity you’re considering and that you map out every feasible option to know without a doubt which investment is the smartest for you.