Guaranteed income streams are becoming more attractive as crushed dreams and investments become the retirement nightmare for most people. With some annuities, you can get this guarantee.
Annuities come in different types. You need to be educated before you commit your money. So here is a guide.
It can be defined as a contract between an insurance company and a consumer (you) to cover certain goals. The goals could be long-term care expenses, legacy planning, lifetime income or principal protection.
An annuity is not an investment, even though some insurers market is as such. It is a contract. Breaking the contract is almost impossible.
Why an Annuity?
Many people buy annuities to get a guaranteed source of income. That is why they are popular in retirement planning. There is no contribution limit and you can save as much as you want.
How Does It Work?
In simple terms, an annuity transfers risk to the insurer from the owner (annuitant). You then pay the company premiums. These premiums can either be paid in a series of installments or a single lump sum.
The payments are not indefinite. After some time, you stop paying and get paid instead. All annuities are not the same. Some pay you for as long as you live, and when you pass a way at a defined time frame, your beneficiary will be paid the remainder.
Different Types of Annuities
Annuities are divided into two categories: immediate and deferred.
With an immediate annuity, the income begins almost immediately. It, however, won’t come right away. After you pay the lump sum, you start receiving income after one annuity period. It could be a year or one month.
A deferred annuity offers a lifetime income and tax-advantaged saving. The payments begin years later.
Principal Protection with Fixed Annuity
The series of payments and minimum rate of return are fixed with this type of annuity, but under predetermined conditions.
Early Withdrawal Penalties
If you choose to withdraw your funds before the specified time, you may incur surrender charges. The charges usually reduce with time.
Investment Risk in a Variable Annuity
The insurer invests your money in different sub accounts if you choose a variable annuity. The rate of return will depend on how these subaccounts perform.
Annuities and Tax
Just as with an IRA or 401(k), you pay taxes when you withdraw the money. The tax depends on whether you funded the annuity with after-tax or pre tax dollars.
Variable annuities have annual fees but most other types don’t. All of them, however, have commissions.
Contrary to how they are marketed, fixed indexed annuities are complicated and they have limited protection and potential.
Riders for Extra Benefits
Riders can enhance the long-term care provisions, legacy or income—but at a cost. They can either be living riders or death benefit riders.
If you die earlier than expected, the insurance company won’t keep your premiums.
Annuity payments are guaranteed by the insurance company, not the government. So the insurer’s financial strength matters.
Annuities present an opportunity cost risk. That is why you need to annuitize gradually instead of paying your premium as a lump sum.
Annuities Are Not for Everyone
People who don’t expect to reach their life expectancy or run out of income don’t require an annuity.
Americans hear a lot about the shaky outlook for Social Security. In the future, the federal program likely will play a smaller overall role in Americans’ retirement plans.
One way to fill in the gaps of a savings portfolio is to put money in annuities. With an annuity, you pay a premium in exchange for guaranteed income payments at regular intervals. It is most often used for retirement purposes.
The basic types of annuities are equity indexed, fixed rate and variable. The major advantage of annuities is that they all guarantee benefits such as tax-free growth, the ability to pass money directly to heirs or charities and an income stream for life.
Over the past few years, equity-indexed annuities have gained a great deal of popularity. They offer interest or benefits that are linked to an external equity reference – a stock index like the S&P 500, for example. But you get a guaranteed minimum return in exchange for a limited maximum return; that is, you get less upside, but also less downside, to your stock-market investing. Your principal is never at risk.
Fixed-rate annuities, on the other hand, guarantee an interest rate and a declared minimum. They have traditionally been the most popular annuities.
Variable annuities provide more options. They enable you to invest in stock, bonds, mutual funds and money-market instruments.
Reputable financial companies, like TrueYield Financial, want to make sure investors are comfortable when purchasing annuities. Here are some tips for the potential investor.
* Be sure the firm you work with is not limited to offering just one company’s annuities. There are many options available, so work with an agent that can get the one that best fits your needs.
* Understand what you are buying. Talk to your financial adviser or agent about which annuity may be right for your retirement portfolio. Fully understand the annuity contract you are considering.
* Define your goals. Annuities can be used to accomplish several financial goals. For example, they can supplement your monthly income or provide emergency funds. Decide which purpose your annuity will serve.
* Ask your agent if you have a “free look” period to review your annuity contract and make sure you have made the right decision.
* Investigate whether a bonus annuity is right for you. Bonus annuities credit premium bonuses to allow a retirement saver to make up for stock market loss or to provide an immediate boost to the account value.