Across the country, people are saving for retirement. It is true that many people lag behind when it comes to setting aside funds for the future, but despite this lag – where the typical couple aged 56-61 has only $17,00 set aside – there are many options available.
One commonly-overlooked option is that of the annuity. In this guide, we’ll share information on what annuities are, how they work, and how they can supplement other retirement savings plans. In short, everything you need to know to make an informed annuity purchasing decision will be presented. Let’s get started.
What is an Annuity?
Perhaps you have heard the term “annuity”, but do not truly understand what they are or what they can do for the retirement savings portfolio. In simple terms, annuities are a type of insurance policy that pays out an income, and remain a popular choice for investors who wish to receive a steady stream of income in their retirement years. The way an annuity works is that the investor chooses an annuity product, then invests in it. Depending on the setup and type of annuity, the annuity then makes payments to the investor in the future.
Income payments may be chosen to be distributed monthly, quarterly, annually, or even in a lump sum if desired. The size of the income payments depends on the amount originally invested, the account value’s growth, and the length of time premium payments were made into the annuity. There are two major categories of annuity, and within those categories are two forms:
- Deferred annuities are those which are invested in over a period of time – usually until the investor retires. Once retirement is reached, the annuity begins to pay out income. The money invested in the annuity grows in value until retirement. There may be penalties for early withdrawals, referred to as “surrender charges”.
- Immediate annuities work in a different way. The investor makes an initial investment, and soon after the income payments begin. This type is often used when the investor is close to retirement age.
A fixed annuity offers a guaranteed payout amount and rate of interest, which is specified in the annuity contract/policy. A variable annuity is tied to the performance of the investments associated with the policy. Fixed annuities may generate higher returns on a tax-deferred basis, depending on the investment performance, while variable annuities fluctuate in value with market performance. It is also important to note that the funds contained in an annuity are not protected or insured by the issuers, although most have some form of minimum guaranteed payout figure in the contract details.
What are the Drawbacks to Annuities?
Annuities are a good choice for many people who wish to diversify their retirement savings plans. They can produce a steady, reliable stream of income after retirement, and therefore help to cover the expenses retirees face after they’re no longer working.
Still, annuities aren’t for everyone. For those receiving Social Security benefits, they are already in possession of a fixed indexed annuity, designed to pay benefits for the rest of the person’s life. People with government- or corporate-sponsored pensions also already have an annuity that makes regular payments for the remaining life of the individual.
Other drawbacks include the potential for substantial annual maintenance fees, which can be as much as 3-4%. Also, there are surrender penalties for early withdrawal from certain annuity accounts, particularly those that are the deferred type. To avoid these penalties, annuity policyholders must sometimes wait 15 years or more for the policy to mature before becoming eligible to make penalty-free withdrawals.
Reasons for Purchasing Annuities
Now that we understand what annuities are and how they work, and have a clear picture of some of the potential drawbacks, what are the upsides to purchasing an annuity? There are several reasons, and these depend on both the type of annuity purchased and the stage of life the individual making the purchase is in.
- Interest rates are rising – with the strengthening U.S. economy, interest rates have climbed, translating to higher payouts in annuities. This rise in interest rates has also whetted the appetites of investors, meaning that annuity choices are more available than in years past.
- Annuities can help meet retirement goals – investing in IRAs, employer-sponsored 401(k) and 403(b) plans are important, but contributions to these plans can be limited and may not equal the amount needed to meet retirement goals. This is especially true of people who began the retirement savings process late in their careers. Annuities supplement these other savings plans, providing guaranteed income after retirement age is reached.
- Annuities build a diversified retirement portfolio – diversification is key to any investment plan at any stage of life. By diversifying the investment portfolio, investors are more able to weather changing market conditions and fluctuating interest rates. Annuities help to diversify the retirement portfolio. Of the annuity types, fixed annuities represent a unique asset class – one of the only investments that is guaranteed not to decrease and can increase at a pre-set interest rate (at minimum). The guaranteed payout and interest rate is tied to the claims-paying ability of the annuity issuer.
- Annuities can help protect a retiree against living past his or her assets – pensions and Social Security benefits provide income for as long as the beneficiary lives. IRAs and other retirement investment vehicles, however, may become exhausted, particularly if a person lives long after retirement is reached. Just like a pension, an annuity pays continuous retirement income for the lifetime of the policy holder, no matter how long that lifetime is.
As with any retirement account, determining if an annuity is right for an individual’s unique retirement needs and goals can be filled with challenges. Speak to a retirement planning professional to gain insights into annuities, including whether a fixed or variable annuity can help you meet your goals. A comfortable financial life after retirement is possible with the steady income and guaranteed payouts of an annuity.
Contact Synergistic Life Services for help today: www.synergisticlifeservices.com
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