All About Annuities: How Do They Work and Should You Invest in Them?
What is an annuity? Is it a smart investment? Should I have an annuity in my retirement plan?
We get questions like these all the time from our clients. Annuities can seem confusing and, as a result, many people invest in them without knowing what they are getting into or if it’s the best option to help fund their retirement. Or they avoid them altogether!
In this article, we are going to cover what you should know about annuities to determine if they have a place in your retirement plan.
What is an Annuity?
An annuity is a contract between you and a financial institution, usually an insurance company, that offers a guaranteed payout to use as an income stream at a determined future date. You can either pay a lump sum payment or have a monthly premium. This contract can have several variations and riders, so it is important to fully understand exactly what you are getting before you commit to making it part of your retirement plan.
The primary benefit of an annuity is that it’s considered a “safe” investment; meaning that the financial institution takes on the risk of a fluctuating market and offers you a near-guaranteed amount regardless of how the market changes.
There are two primary types of annuities: fixed and variable. A fixed annuity pays back the money you put into it with interest at a predetermined rate. Think of a fixed annuity as a relatively low-risk investment. You don’t invest in it because it has the potential to grow exponentially; instead, you invest in it because it is safe. In contrast, a variable annuity’s return is based on how the market performs. It will pay out more if it performs well, while minimizing the risk if it performs poorly.
What is the Downside to Annuities?
Annuities have rules about when you can start taking money out of them. If you purchase an annuity and then a year or two later decide you would like to invest it elsewhere, or that you need the money now, you will have to pay a hefty fee to get your money out. You’ll want to make sure you understand the policies in advance.
In addition, an annuity isn’t a high-earning investment. Depending on your age, other investments, and how much time you have before you retire, an annuity may not measure up to other investments that may have higher potential for greater returns.
There are also riders that you can add to your annuity for a fee. These riders may have some benefits, but they also come at a cost to you, which is why it is so important to make sure you understand every part of the annuity you are looking at before you sign on the dotted line.
What are the benefits to annuities?
The number one benefit to annuities is security. Annuities offer minimal risk to provide consistent income once you retire. When considering funding your retirement, the most talked-about investment strategy is the 60/40 rule. This rule states that 60% of your investment strategy should be to get gains on your investment while the other 40% should be to secure fixed income. This strategy tries to help mitigate risk while still investing in some higher-risk options.
As far as your return on investment, an annuity is much better than leaving your money in a savings account. However, that is only true if you are sure you won’t need any of that money until you retire.
Should I Have Annuities in My Retirement Plan?
Even without going in-depth into all the variations, riders, and rules of an annuity, it can be difficult to know if you should include them in your retirement plan. Some of the factors you need to take into consideration are how much time you have to fund your retirement, what other investment options you have, and how much of your current income you need right now.
An annuity can be a good option if you would like an investment that minimizes risk, you are near retirement age and don’t have a lot of time for an investment to mature, and you fully understand the specific type of annuity you are purchasing.
Every situation is completely unique, so if you’d like some advice as you develop your retirement plan, please consider scheduling a complimentary one-on-one consultation with one of our financial advisors here at 210 Financial. We’d love to talk with you about your retirement plan!
Annuities are insurance products that may be subject to restrictions, surrender charges, holding periods, or early withdrawal fees which vary by carrier. Guarantees are backed by the financial strength and claims-paying ability of the issuing insurer. Riders are generally optional and have an additional associated cost. Annuities are not bank or FDIC insured.
Content prepared by Savage Content Collective
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