What Is an Annuity? Hype or Hope for Your Retirement?
Annuities: Hype or hope for your retirement?
The simplest way to describe what is an annuity is that it is a way for you to buy income without risk. Annuity payments can provide income monthly, annually or in a single lump sum. They can be paid out over a set period, say five years, or for the rest of your life. The amount of these payments depends on the amount you invest and the type of annuity you purchase.
Annuities are typically sold by insurance companies, banks, and other financial services companies. According to the Securities and Exchange Commission (SEC), there are three main types of annuities:
- Fixed annuities: The insurance company promises you a minimum rate of interest and a fixed amount of periodic payments. Fixed annuities are regulated by state insurance commissioners.
- Variable annuities: Your payout will vary depending on how much you invest, the rate of return on your investments, and plan expenses. The SEC regulates variable annuities.
- Indexed annuities: The insurance company pays you a return that is based on a stock market index, such as the Standard & Poor’s 500 Index.
What makes an annuity good or bad really depends on your goals for the product and how well you tailor the annuity to your needs. Annuities are very flexible financial products that can be tailored to suit your financial goals.
Are annuities hype or hope for your retirement?
Different people have different perceptions of annuities. If you were to ask different financial advisors and different retirees, “what is an annuity?” you would get widely varying answers.
While some financial planners believe that the products are too expensive and not flexible enough, many other advisors as well as financial services companies and the federal government hype the product:
- You have likely been inundated with advertisements from financial services companies promoting annuities as a way to “protect your money” and earn “guaranteed income” at “low risk.”
- The IRS and the Treasury Department are promoting the use of deferred income annuities in 401(k) accounts” to help retirees not outlive their retirement nest egg.
However, annuities — especially when carefully researched and purchased from a reputable broker — do offer real hope for anyone worried about running out of money in retirement.
Annuities can give you the confidence that the income you want will be there when you need it.
However, before you consider making annuities a part of your retirement plan, read the information below to better understand what is an annuity — the costs, complexities, pros and cons of annuities and how to assess if an annuity is right for you.
What is an annuity? What are the advantages? Where is the hope?
Annuities can offer the promise of guaranteed income for life. That’s an easy sell for most.
The truth is that most of us are worried about having adequate retirement income for the rest of our lives — no matter how long that turns out to be.
Annuities have grown in popularity recently in part because there is no annual contribution limit. Meaning, high net worth individuals can put away more tax-deferred cash than is allowed under a 401K or IRA. For others, an annuity is a useful means to essentially ‘catch up’ to all the money they could have put into their 401(k) over the years but didn’t.
Tax limitations can be another big advantage of annuities. In some annuities, any money you put in can be tax deferred. When you start receiving payments, your contributions are still not taxed, only your earnings, and these are taxed at your regular income tax rate, which is likely to be lower in retirement years.
Many also like the peace of mind an annuity promises, as it can be set up to provide guaranteed payments for specified period or even for the life of the beneficiary. As life expectancy increases, this is becoming a critical issue.
What are the disadvantages of annuities? What is the hype?
All investments have risks and variable annuities, in particular, which offer a range of investment vehicles and expenses, may prove complex to those who are not seasoned investors or who can’t rely upon a trusted financial advisor.
That said, all annuities have some potential downsides. One of the chief complaints about annuities is that many come with high sales fees. Insurance salesmen and financial planners may be financially incentivized to promote annuities even if they are not exactly right for your situation. However, not all annuities come with a high sales commission. If an annuity is right for you, and you have a trustworthy planner and have compared fees and options, an annuity can be a welcome addition to your retirement plan.
There’s also the concern that management fees and expenses are typically much higher for an annuity than many other investment vehicles. Oftentimes, these run about 3 percent a year versus less than 1 percent for many popular mutual funds.
Annuities also have more limited upside potential.
Another downside to an annuity is the so-called surrender charge. That is, if you take money out of an annuity within the first several years after you purchase it, there may be a fairly high surrender charge, anywhere from about 5 – 10 percent of the account value, depending on the timing of the early withdrawal.
There’s also the risk, however small, that the company you purchased your annuity from won’t exist in ten or twenty years. To guard against this possibility, make sure you purchase your annuity from the most trusted, credit-worthy insurance companies. States regulate the industry and offer some – but not complete – protection from such an event. The Securities and Exchange Commission offers additional guidance on annuities.
Why did annuities become so popular?
In 2014, the US Department of Treasury issued rules regarding annuities. The Treasury lauded annuities for their potential to give “American families more flexibility to plan for retirement and protect themselves from outliving their savings.” Thanks to the Treasury’s rules, individuals can move up to 25% of their 401K or IRA to purchase a qualifying annuity. The new rules also effectively opened up the market for selling annuities.
Plus, as more baby boomers retire and expect to live well past 65, the security of receiving regular supplemental payments has proven particularly appealing.
How do I get paid by an annuity?
When you purchase an annuity, you will be faced with many decisions. There are many options and it may seem daunting. Here are a few ways an annuity might pay you:
- You can select a guaranteed period, 10 years, for example. Or you can opt for lifetime — no matter how long that turns out to be.
- You can make sure that monthly income grows to keep pace with inflation or not.
- You can guarantee return of principal. And, if you die before the end of this period, your beneficiary receives the remaining payments or a lump sum.
- You can opt to start your annuity payments immediately or at some point in the future. When you start payments in the future it is called a deferred annuity. Deferred annuities can be particularly interesting as a way to fund long term care.
Everyone’s situation is different. You might want to experiment with an annuity calculator to see what different payment options are available and how much income you can receive.
What is an annuity? Is it right for me?
Annuities offer peace of mind in knowing you will receive a select amount of money, month after month, year after year. This notion of a lifetime income, almost like a pension, is particularly important as people live longer, and as medical costs increase.
However, there is a lot of hype around these products and they truly are NOT for everyone.
Before purchasing an annuity, you should have a solid understanding of your finances throughout your retirement years. You will want to know how much you will be spending throughout your retirement and what various sources of income you will have.
The NewRetirement retirement calculator enables you to assess your overall retirement plan from now into the future. You can see if you need an annuity, if you have enough money to purchase an annuity and even assess how an annuity would impact your plans — immediately see if it has a positive or negative impact on your cash flow, net worth and estate.
This planning tool was designed to enable you to learn about important financial planning issues. As you make changes to your plan and try out different options, you can immediately see the impact of these modifications.