Annuities are a long term investment for your retirement, providing a monthly income to you once your annuity enters it’s “annuitization” period. There are many different types of annuities ranging from ultra conservative fixed annuities to more stock market like variable annuities.
Annuities are no different than any other investment in that there is the possibility of benefit accompanied by risk. There are several options when it comes to annuities, so you can personalize your investment portfolio in a way that makes the most sense for you.
There seems to be a general consensus that investing is a key necessity for planning on the future, especially when considering retirement income. There is also a general consensus that the best retirement plans are well rounded and contain a multitude of diverse investments. Annuities can be a beneficial part of that diversity, but they do not belong in everyone’s portfolio.
Saving money without discipline is difficult for many people, so giving your money to someone else to save and invest for you is convenient. It is also nice to know that by doing so you have future income for your retirement days.
However, as with most investment funds, there are no guarantees and there are always risks. There are penalties and fees associated with various annuities that may make annuity ownership cost prohibitive. It is also important to understand how the death benefit works on an annuity before deciding if it is right for your retirement plan.
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Type of Annuities
There are fixed annuities, indexed annuities, variable annuities, and immediate annuities. Each type of annuity has its own purpose and benefits the annuity owner a certain way. With most annuities, the insurance company is the recipient of your money once you die, so if you have dependents you need to talk to your financial advisor about the best annuity for your family.
Fixed annuities are prearranged to payout a specific set amount on a monthly basis based on a number of factors determined at the time the contract is drawn. The age of the annuity holder is a key component to determining the details of the fixed annuity contract because the insurance company needs to calculate the expected payout (which means estimating your life expectancy) in order to determine how much to charge for the annuity.
Since fixed annuities offer a guaranteed rate of return, the investments are usually very conservative. Insurance companies need to take your initial payment and invest it wisely so that it sees some growth. There is no time for long term risk taking with a fixed annuity. For this reason, people who are closest to retirement age are most suited for this type of annuity.
Indexed annuities put a little bit of growth risk into the portfolio plan. These kinds of annuities are also good for people who are close to retirement age, provided they are okay with a fluctuating market.
Unlike the fixed annuity, with an indexed annuity you are investing in a financial index that varies with the market. This means your rate of return will vary and may not always give you the performance you expect. However, since there is more risk involved, there is also the possibility that you will see a higher payout in return.
Variable annuities are different in that they give the investing power to the annuity holder. Variable annuities are treated more like mutual funds with higher fees and expenses, so they may not be the best option for everyone. Variable annuities are geared for someone who is able to take a greater risk with their investment to try to maximize their return.
One of the benefits of the variable annuity is in its treatment of the death benefit. Unlike other annuities where the insurance company claims any death benefit from your annuity, the variable annuity account holder can actually name a beneficiary.
Immediate annuities are restricted for people who have the money to pay for their annuity upfront in the anticipation of having it conservatively invested while starting to make payouts almost immediately.
With an immediate annuity, you still have the option of having your annuity be a fixed one or a variable one. With a fixed annuity the underlying investments are controlled by the insurance company and with a variable annuity the underlying annuity investments are controlled by the annuity holder.
Annuity Payout Options
Once you decide to purchase an annuity, you will find out how much your annuity will cost and how much money and how often you will have to contribute to your account. Before the contract is finalized, you need to also determine what type of payment option you want.
Payouts can be scheduled based on an annuitization method, a systematic withdrawal schedule, or a one-time only lump sum payment agreement. You can also elect not to take your payouts and have your beneficiary receive all of your benefits when you die if you can name a beneficiary for your annuity.
There are several choices of payout in the annuitization schedule. The life option allows you to collect your payouts all the way through your lifetime while the joint-life option allows your spouse to collect the payouts after you die.
You also have the option of buying your annuity for a set term, such as five years or even 15 years. If you live beyond the years selected in that term, then your annuity will simply cease paying out benefits to you. Another option is to buy a lifelong annuity with a guaranteed term. This allows your beneficiary to claim some sort of limited payout based upon the term selected.
People who are interested in receiving a large set amount of money from their annuity every month can actually set up a systematic withdrawal schedule. This type of payout is set up with the insurance company in advance and it cannot guarantee that your payout benefit will outlive you, especially if your planned income is high.
If you are in a desperate situation, you do have the option of withdrawing all of your money in one lump sum. The problem with this is you will have substantial fees and penalties since you are not actually using your annuity the way it is intended.
Annuity Fees, Charges, & Costs
The costs of annuities can make them more expensive than some other investment options. Variable annuities have the highest fees, although some people find this additional expense worth the cost in order to be able to name a beneficiary. As with many money market funds, there are commission fees that will be withdrawn from your annuity accounts as well.
Surrender fees are put in place on annuities to discourage you from closing your account early or withdrawing money prematurely. The longer you have your annuity, the lower these fees typically are, but you can expect to pay anywhere from 1% to 6% on surrender fees.
Annuity Tax Benefits
Annuities provide a tax shelter by giving you tax deferred income. However, just like IRAs and 401ks, annuities are intended to provide you with financial assistance in your senior years. Therefore, as an incentive to keep you from taking your money before the age of 59½, you will be charged an early withdrawal penalty tax of 10%.
Since annuities are only tax deferred, you can expect to pay income taxes on your gains when you actually start to withdraw the funds. Income taxes can be high, especially with variable annuities, so you should check with your tax advisor before deciding which annuity makes the most sense for you.
The intention of annuities is to provide you with a source of income during your retirement years. No retirement portfolio should be based on only one type of investment option. However, annuities may be a sensible selection as one component of it. Depending on your age and your investment comfort level, annuities may be worth considering.
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