If you’ve started to plan for your future, then you’ve likely come across an annuity. There are some appealing advantages, but they are complex and some have drawbacks to watch out for. Choosing this type of retirement plan can offer you more control over your future financial circumstances. That being said, not all annuities are created equal and there are annuity risks that you should factor in when making your decision.
Let’s break down what an annuity is and if you should consider one.
What Is An Annuity?
An annuity is a contract sold or distributed by financial institutions, typically for retirement. The goal of an annuity is to pay a fixed income stream in the future. When you invest in an annuity you receive payouts (in the form of income) over the course of several years or for the rest of your life.
There are two main types of annuities: deferred and immediate. The difference between them is when you begin receiving payouts after your investment:
- A deferred annuity pays you at a future date or when you retire.
- An immediate annuity makes payments available to you immediately after your first contribution.
You can also decide if you’d like a fixed or variable annuity. With a fixed annuity, you can expect a consistent payout. The payouts of a variable annuity will change based on your product or company’s performance.
Advantages of Annuities
#1 Security
Perhaps one of the most prevalent reasons to consider an annuity is security. Many people close to retirement are simply not comfortable with the risk of volatility in the stock market, and they prefer to place at least a portion of their savings in a more secure investment.
#2 Tax Benefits
Many people consider the tax benefits of annuities one of their greatest attributes: specifically, the interest on annuities grows tax-deferred, which allows the overall value of annuities to grow faster than if tax had to be paid monthly, quarterly or annually on earnings. Annuities can also be purchased with post-tax money, which means that the annuity owner will owe taxes on earnings only upon withdrawal (retirement, typically).
#3 Estate Planning
As insurance products, annuities must have listed beneficiaries. This creates a framework and structure for estate planning, but it also, if structured properly, allows that money to pass to beneficiaries without the money being subject to probate.
Disadvantages of Annuities
#1 Some have higher fees
Some annuities can have higher fees than other retirement options. Brokers may collect commissions of up to 10% in a sales charge. There are also surrender charges if you withdraw too early and higher annual fees nearing 3% a year or more. This is a risk with virtually every financial product, and that is another reason you always want to get a clear, transparent answer when you ask exactly what you’re paying for.
#2 Limited liquidity
Most annuities do allow some limited liquidity. Plus, many contracts allow you to remove the earned interest on a monthly basis. What’s more, if you need total access to your premium (known as a return of premium clause), that is also possible with some annuity contracts, though this comes at a steeper cost. However, most annuities work best as a part of a retirement plan that includes separate emergency savings.
#3 Insurance companies
Even if you use a third-party broker to make the deal, the issuing insurance company is responsible for the annuity itself and all the things you bought it for—managing the investments and paying your income. There’s no FDIC insurance on insurance products, so doing your research on every insurance company you do business with is a don’t-ever-skip step.
Taking the Right Step Towards Retirement
Annuities are complicated and not every contract will be a good fit for your needs. While they seem appealing at first glance, they might not be the right choice for your financial planning needs. Talk to our team at Trajan Wealth so we can help you weigh the pros and cons of annuities and find the best strategy for your retirement.
