What Is An Annuity?

What is an Annuity?

If you are planning your retirement, there’s a likelihood you’ve heard of annuities either through friends or a financial advisor.  But what is an annuity, and is it  good tool to incorporate into your retirement plan.  We’ll discuss the basics of an annuity here along with some of the different types of annuities.  If these products sound like something you’re interested in, you should discuss them with a trusted financial advisor to better understand how they might complement your current retirement plan.

At it’s most basic, an annuity is an insurance product that you purchase which provides future income.  Annuities can be immediate, meaning you start getting payments as soon as you purchase the annuity, or deferred, where you get paid at some point in the future depending on the contractual details of the annuity.

There are many different options with annuities when it comes to how they are paid out.  You can purchase annuities that provide monthly, quarterly, or in some cases lump sum payouts.  It’s most common to receive these payments monthly or quarterly as a main reason for purchasing annuities is to provide regular income to someone in retirement.

Types of Annuities

There are four main types of annuities.  Immediate, deferred, fixed, and variable.  As discussed above, the immediate and deferred types indicate when you begin getting payouts on an annuity.  Taking a step further, each of those can then be purchased as a fixed or variable.  A fixed annuity is less risky as it pays out a fixed rate of return and guarantees the principal investment.  A variable annuity is one that gives you more control over the investments within the annuity, typically mutual funds, but also brings more risk as those funds are at the mercy of the mutual funds that make up the annuity.

Pros and Cons of Annuities

You will find a wide spectrum of opinions on annuities, with many different pros and cons being listed.  This is why it is so important for you to consult and advisor that you trust before making the decision to purchase an annuity.  Also check our article on Who Buys Annuities for more incites.

One of the biggest benefits of an annuity is its tax deferral status, which allows any earnings on the investment to be paid later in life.  As with all tax deferred products, such as your IRA or 401k, the thought is that you will be withdrawing those funds when you are in a lower tax bracket in retirement.  That’s why annuities can be particularly attractive to those in high tax brackets during their working years.  Another common benefit cited about annuities is the potential for them to provide a secure income stream for a period of time, or even for life.  Some people view this as an added security to their retirement.

Detractors of annuities will quickly tell you about how complicated annuities can be, and how careful you need to be about the fees, surrender charges, and other fine print items within the annuity you purchase.  These are in fact the biggest issues to watch out for, and can make annuities less attractive from a pure investment standpoint.  That said, as long as you go in with full knowledge of the details of your annuity, and that you may not be maximizing investment dollors perse, but instead purchasing the security of future payments (that is of course why these are insurance products after all), then an annuity can potentially be a beneficial part of an overall retirement plan.

Regardless of whether you decide an annuity is a good addition to your retirement portfolio, one of the key things you need to look out for is the strength of the institution you are purchasing from.  Always ensure the broker or agent you are purchasing from has provided you the insurance company rating, and that you’re comfortable they will be around for the long haul.  If you buy a lifetime annuity, you want to make sure that institution has a very low chance of defaulting on whatever product you buy.  For that reason, be sure that you’re not solely focused on cost when making purchases.

Annuity Summary

Annuities can be tricky, and their can be a lot of fine print.  As with almost all of our recommendations, we think reviewing annuities with a trusted advisor can help you sort out if purchasing one is good for your situation.

They can play a part in a broader retirement plan, and have positive aspects that can help provide security for a number of years into retirement, if not for the rest of your life.  There are also some pitfalls based on your situation, or based on individual annuity products and the companies offering them.

If you are approaching getting to a point in life where you are seriously planning for retirement, you should at least have the discussion with your advisors as to whether an annuity would be good for you.

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