As you plan for retirement, what can you do today to ensure you’re set up for financial success in the future? Will you have enough money saved? Do you have a plan for supplementing your income? Maybe you can benefit from added income before retirement?
If you can resonate with any of these situations, an annuity may be for you. Let’s look at how they work, what options you have, and discuss their pros and cons.
How they work
An annuity is a long-term financial tool that can set you up for lifetime income. It’s essentially a product (sold by insurance companies) that guarantees you won’t run out of money if you live a long time.
When purchasing an annuity, you choose to either pay in one lump sum or make regular payments over some time. That time can be immediate or in the future, depending on the type of annuity you invest in. It can be paid out in one lump sum or as a series of payments over time.
Let’s review the types of annuities available to you, so that you can find the right fit for your needs.
The word “fixed” may be deceiving, as the interest rate on a fixed annuity can change over time. Your contract will explain when and how this can happen. But typically, your rate is set for a certain number of years and then changes periodically based on current rates. Your money and earnings grow tax-deferred until you’re ready to start taking income. The growth rate and/or the benefits paid may be fixed at a dollar amount or by an interest rate or may grow by a specified formula.
A perk of fixed annuities is that they’re a minimal risk. Their guarantee period can be anywhere from one to 10 years. They’re most often the best type of annuity for retirees, or people looking to retire within a couple of years. But they’re certainly not the only option when it comes to a retirement annuity.
When considering a fixed annuity for retirement, be sure to consider what you want your money to do and when you want to have access to it.
Indexed annuities are a hybrid that combines features of fixed and variable annuities. They offer a minimum return, and their return rates follow the stock market. But they are also linked to the performance of a specific index, often the S&P 500. However, some indexed annuities allow investors to select more than one index.
Because of the guaranteed interest rate, indexed annuities give you more risk than a fixed annuity, but less risk than a variable annuity. It’s a healthy mix of the two, but there’s more.
The added value an indexed annuity offers is that it allows buyers to benefit when the financial markets perform well. As shared by Investopedia, the guaranteed minimum return (in most states) is 1% to 3% interest on at least 87.5% of the premiums paid. These provisions vary by company, so reading the details of the contract is crucial. You’ll also want to understand whether or not there’s a cap on market-based returns. For example, their maximum payout could be 8%, so even if your index outperforms that figure, you’d still only make 8%.
401k rollover annuities
A 401-k is an employer-sponsored retirement plan. It’s a savings plan geared toward workplace employees, and it doesn’t stick around per se when you move on to something bigger and better. So what do you do with that money? Well, when you leave a company, you can cash-out (assuming you’re of retirement age) or move it into another retirement investment account. Some people will roll their money into an individual retirement account (or IRA), while others choose a 401k annuity to take advantage of income protection. That money can be moved into any of the above annuities. It just depends on what your goals are and when you plan on retiring.
- Annuities can be jointly owned
- Your money grows tax-deferred until you start receiving payments
- You can receive regular, lifetime payments as supplemental income — your money won’t run out
- Some annuities begin payments within a year
- There are no yearly contribution limits; add as much money into an annuity as you like
- You’re able to transfer assets without probate
- You’re able to consolidate 401k plans that you have with multiple employers into an annuity
- Variable annuities often come with a standard death benefit, which pays your beneficiaries the total of your premiums minus withdrawals and fees (if you die before payouts have begun).
- Optional riders can also enhance what your heirs may receive.
- You’ll pay high fees
- You often cannot get your money back
- As interest rates push closer to zero, you receive less return on investment
- Variable annuities include a mortality and expense (M&E) risk charge that is generally around 1.25% of your account value. This is an annual fee to compensate the insurance company for taking on the risk of insuring your money.
- If you withdraw money before the surrender period, which ranges from one to 10 years, you’ll pay a surrender charge which can be as high as 10% of your withdrawal
- Market based returns may have caps
Tax-deferred annuities come with different payout options, all of which should be considered when you hit retirement age. Accessing money any sooner can be costly.
When it comes time to retire, you can “annuitize” the plan, which will switch it from its “accumulation period” (when you pay in) to its “amortization period” (when you get paid). The actual payout can happen in two different ways: immediate or deferred payments.
With an immediate annuity, you will receive one check per month for the rest of your life, regardless of how long you live. Your payout amount is based on your account size, interest rate, and life expectancy. It’s a strategic solution if you need access to money sooner than later.
With a deferred annuity, also known as longevity insurance, the checks arrive later in life. And that can be a good thing because the longer you wait to draw money, the bigger your payout will be. Simply put, your money grows over a long period according to market performance. While there is no income guarantee, you can buy a rider that includes a “worst-case scenario” clause and ensures a minimum return rate, which is often near 5-7%.
Learn about using a 1035 exchange.
Understanding your investment
The bottom line is annuities can vary radically. But, annuities are the only investment that can guarantee income for life — no matter how long you live.
If you’re close to retirement or want to broaden your investment portfolio, they’re certainly a vehicle worth considering. Give one of our financial advisors a call to learn how annuities may fit into your investment strategy.