If you’re starting to plan for your retirement, chances are you’ve probably thought about purchasing an annuity. More and more people are looking to annuities as pension plans are no longer viable sources in most places of work. Annuities can be used with your social security and any other retirement savings you have. It’s a great option if you’re wanting a recurring stream of income you can depend on. An annuity can be used in many beneficial ways during retirement:
- Pay for retirement goals – You can use your guaranteed annuity income toward things you’ve always said you would do in retirement, like hobbies, travel, and other things.
- Cover fixed expenses – If you still have fixed expenses like rent, mortgage, utilities, etc., in retirement, your guaranteed annuity income can be used to help cover some of these expenses.
- Use as you need – Having additional income in retirement is just assurance to be able to do what you want to do in retirement without having to worry about not having the money to do so. Use your guaranteed annuity income as you need or as you see fit.
But an annuity may not be for everyone. As with anything, there are reasons why it may not benefit you as much as someone else. So, we’ve determined four signs that are sure to let you know that an annuity can help you fund your retirement.
What Is an Annuity?
Annuities are contracts you make with an insurance company that promises to pay you a guaranteed income for the remainder of your life. They can be bought in a series of payments or in one large payment, and the insurance company sends payments over a period of time, either monthly, quarterly, or annually. These payments guarantee a stream of income during your retirement years. Annuities need to be purchased years before your retirement. They can be purchased through a series of payments or with a lump sum payment.
Annuities offer a degree of protection from market drops. This growth is typically tax-deferred, which may be appealing for people who are looking for additional sources of tax-deferred retirement savings beyond accounts such as IRAs and 401(k)s.
Types of Annuities
A fixed annuity provides a fixed amount of income, over a specific number of years or over your lifetime. A fixed annuity allows you to know how much your regular payments will be. You will always get this amount when you receive your annuity payment.
A variable annuity provides more opportunities to grow your money through a variety of stocks and bonds. While it’s an opportunity for more growth, it’s also a bigger risk for your money. Your regular payments are based on how well your investments did in the market, and therefore, are less predictable than the return of a fixed annuity.
Fixed Indexed Annuities
A fixed indexed annuity offers growth, safety, and access to optional riders that can guarantee lifetime income. This type of annuity is tied to an index, such as the S&P 500. Index-linked interest, along with tax deferral, helps your money grow. And if the index performs poorly, an index annuity retains its values and loses nothing.
How Annuities Are Paid Out
Annuities will pay you guaranteed income during retirement in two ways: immediate or deferred.
Immediate annuities, as the name implies, pays immediately after the annuity is purchased. For this to happen, the buyer makes a lump sum payment right before they retire. It’s paid as a one-time payment and the payout begins less than a year from the purchase, depending on the terms of your contract.
This option is best suited for people close to retirement age looking to use a portion of their nest egg to ensure steady payments throughout retirement.
Deferred annuities, on the other hand, are purchased years before your retirement and are built over several years. Premiums are often paid in smaller amounts over time. Payouts start sometime in the future after you retire. This allows your money to grow, either as interest if you have a fixed or fixed-indexed annuity or with stock and bond market gains if you have a variable annuity.
The Downside of Annuities
While annuities sound good, they’re not always the obvious choice for people. There are fees involved and penalties should you decide to tap into your income source too early.
Most annuities come with fees in exchange for their benefits. Annuities also typically don’t allow owners to withdraw all of their money during the early years without paying penalties (surrender charges), making them a complement to plans that have other sources of liquidity for cash needs.
You may pay several charges when you invest in a variable annuity, so be sure you understand all charges before you invest. In addition to surrender charges, there are a number of other charges that include:
- Mortality and expense risk charge. This charge is equal to a certain percentage of your account value, typically about 1.25% per year. This charge pays the issuer for the insurance risk it assumes under the annuity contract. The profit from this charge sometimes is used to pay a commission to the person who sold you the annuity.
- Administrative fees. The issuer may charge you for record-keeping and other administrative expenses. This may be a flat annual fee or a percentage of your account value.
- Underlying fund expenses. In addition to fees charged by the issuer, you will pay the fees and expenses for underlying mutual fund investments, which average out to be between .75-3.25%.
- Optional rider fees. Additional fees typically apply for special features, such as a guaranteed minimum income benefit or nursing home benefit or added death benefit.
- Penalties. Depending on the tax code the annuity is issued with, if you withdraw money before you turn 59 ½ the IRS may charge a 10% tax penalty to the Internal Revenue Service on top of any taxes you owe on the income.
4 Signs an Annuity Can Help Fund Your Retirement
So, should you purchase an annuity or not? There are some signs to tell if an annuity could be the right move for you in retirement.
1. You’re worried you’ll outlive your money
Annuities make sense if you expect that you’ll live a very long life. No one in retirement wants to be without access to funds. Although we may put away for our retirement years, it’s sometimes hard to know if we’ve saved enough. After all, none of us know how long we will live.
The good thing about annuities is that their primary benefit is to have a stream of income during retirement, for the rest of your life. So, even if all of your other retirement savings run out, you will always be able to depend on your income from your annuity.
2. You won’t have enough money in retirement.
Whether you’re afraid you’ll spend too much or too little in retirement, an annuity could help you have more control. Sometimes, when you’re drawing income as you need rather than maintaining a regular income source as you did before retirement can seem awkward. You worry if you’re drawing too much or too little. You want to manage it as best you can without dipping into the pot too much. Knowing you’re getting a regular stream of income through an annuity adds a sense of security and comfort. It also helps you to better manage other retirement savings, so you don’t have to dip into it too hard or too often.
3. You’re a conservative investor
If you’re conservative with how you invest and don’t mind that you may not get the best returns, the security of an annuity might be worth the sacrifice. It might also help you to feel that you’re taking less risk. If you’re a conservative investor, annuities provide that extra security blanket. You don’t have to feel like you’re risking so much with the potential to lose everything.
4. You’re looking for a tax-deferred way to save
Another sign that an annuity may be right for your retirement plan is if you’re looking for a tax-deferred way to accumulate more for retirement but have maxed out your 401(k) or IRA. With an annuity, gains aren’t subject to income tax until income payments begin or money is withdrawn.
While an annuity may not be for everyone, it can be a key part of an overall retirement strategy for someone who feels they can benefit from it. Together with other income sources like IRAs, 401(k) plans, life insurance, etc., annuities can help create a well-rounded retirement plan. An annuity can also be a form of paycheck replacement during retirement. The payout provides a steady, scheduled income that you will keep receiving for as long as you live. That means you don’t have to worry about outliving your income.
By buying an annuity, you can diversify your retirement portfolio, giving you more financial flexibility in retirement. Contact us today to speak to an annuity professional.