People are turning to annuities in droves to help strengthen their financial plan for retirement. Barbara Freidberg wrote about the “5 Best Annuities for Your Financial Plan” in a recent article for Go Banking Rates. Annuities are a strong retirement income option because state insurance departments regulate the products. The best way to determine if an annuity is right in your personal financial planning is to understand how each different type of annuity works and the benefits they can offer you.
The basics of annuities are the same, even though the detailed workings are different with different types of annuities. You buy an annuity from an insurance company with either a lump sum or a series of payments that make up your principal. Your money grows based on either a fixed rate or the market interest rates. When you retire, you can take your money in a lump sum or annuitize your product and receive monthly income for the rest of your life. The two categories of annuities are immediate and deferred. Within both of these groups, your annuity product can be fixed or variable. You can choose for your annuity to pay you for the rest of your life or for both you and a spouse’s lifetime. Understanding the details of each annuity type is important before deciding to purchase one.
Fixed Index annuities are very popular right now. They are sometimes known as a mix between a fixed and a variable annuity. They guarantee a minimum payment and then link your returns to a specific stock market index. How much your annuity grows will help determine the amount of your future income payments. The insurance company can cap your gains and issue a participation rate as well, so those are important details to know. There is usually a surrender period of 6-8 years with any fixed indexed annuity. You can buy one at any age, but will be penalized if you take the money out before age 59.5. Your principal is protected from market losses with an indexed annuity. Since the calculation of index returns can be complicated based on the insurance company, some people believe that these products are too complex.
The second type of annuity is a variable annuity product. Your returns are linked to the markets because you choose underlying funds to invest your money in. There is an accumulation phase where your money goes up and down with your funds. In the distribution phase, your payments will be based on the premium you paid and any investment gains your account received. Most variable annuities have a death benefit that pays your beneficiaries your annuity payments after you die. The same age requirements apply to variable annuities as they do to indexed annuities. Variable annuity products have a menu of fees, surrender charges, and a minimum up front investment. These products offer tax advantages, but also have the potential to lose money if markets perform poorly.
Deferred income annuities have been used increasingly over the past few years. They offer you a fixed stream of lifetime income that is bigger the longer you wait to start receiving payments. You cannot take a lump sum distribution with this type of annuity product; you must opt for the income stream of payments. Payments can start anywhere from a year to 40 years in the future. You can buy a deferred income annuity at any age. Individual annuity contracts determine the surrender charges, minimum investment amounts and fees. Deferred income annuities are good for people that are worried about outliving their savings in retirement. You can add on optional cost of living adjustments if you are worried about that particular risk as well.
On the flip side of deferred income annuities are immediate fixed income annuities. These are typically bought at retirement and they start paying your income right away. They are sometimes referred to as single premium immediate annuities (SPIAs). This is the simplest form of an annuity and a product that offers guaranteed lifetime income that makes your financial plan more predictable. You can add an inflation-rider and choose a joint and survivor option that pays for both your lifetime and a spouse’s lifetime if you so choose. There is a large range of options to choose from with each different annuity provider. Immediate fixed income annuities help you achieve financial security in retirement and are also good options for inheritance money or an IRA rollover.
Fixed annuities are the fifth annuity type discussed in the article. You pay an insurance company a lump sum or multiple payments in exchange for an income stream. Your interest rate is guaranteed during your surrender period. Sometimes it changes after that time frame and with some products it remains the same. Fees, deferral periods, and interest rates will all vary with different insurance companies. Fixed annuity products are the most conservative of the annuities. People who must know their exact retirement income are well-suited for this type of annuity. Some consumers worry that they will have lost out if interest rates increase after they lock in a fixed annuity rate. While it is possible for rates to go up, their benefits often outweigh that so-called risk.
Annuity products are best used to bridge the gap between your retirement expenses and any other income you will have coming in during retirement. Your money grows tax free and there is no limit on how much you can invest in annuity products. Don’t buy an annuity that is too good to be true because insurance companies are of course in the business of making money. Research the individual types of annuities and determine which benefits best suit your retirement income needs. All annuity products have benefits and drawbacks, so it is a balance to see which product is best for you. Speak with an expert if you have any questions about using annuities in your financial planning.
Written by Rachel Summit