The Basics About Annuities
Where Do Annuities Come In?
Investors have different financial needs. Sometimes annuities can help meet those needs, sometimes not. As an investor you need to determine if annuities are a good fit for your personal financial situation. Many investors use annuities as a financial tool to enhance their financial portfolio. You may hold investments such as stocks, bonds, mutual funds and life insurance. If those investments are not enough to meet your financial needs, annuities can be used to bridge any monetary gaps.
Even though annuities can be beneficial, they have been described by some as complicated and even expensive sometimes. If used properly though, annuities may be the right financial tool for you. But, before investing in any type of investment, it is best to do your research and understand that investment. It is a bad habit to put money into an investment that you know little about.
What Is An Annuity?
An annuity is a long-term investment usually designed to supplement retirement income, but can also be used for other investment needs. An annuity can guarantee a stream of income for as long as you live, no matter how long that may be. This lifetime guaranteed income feature is one of the reasons annuities have become a very popular investment for individuals approaching retirement. Think about it, when you are ready to retire, you want stability and guarantees. However, stock markets do not give guarantees. The last thing a retiree needs is a shaky income base; annuities can stabilize your retirement income base.
Determine If Annuities Are Right For You
There are different types of annuities. The first step in determining if annuities are the right fit for you is to learn about the different types available in the market place. The investments within an annuity can be fixed or variable. The annuity contract can be deferred or immediate.
Fixed annuities have a minimal exposure to market risks. Fixed annuities are comparable to CD’s. When you buy a fixed annuity contract the investment that the annuity company invests your money in a safe, fixed investment which does not change in value with market fluctuations. So with a fixed annuity your principal earns a fixed rate of return throughout the life of the contract. Your monthly stream of income is also guaranteed.
One of the advantages and disadvantages of a fixed annuity is that your payouts are locked in. The advantage being that you will always know the exact amount of your monthly payment; your payments will be predictable. The disadvantage is that inflation may eat away at that exact monthly, guaranteed payment. When inflation reduces your monthly payout, you obviously lose purchasing power. However, for a fee you can include a cost-of-living adjustment (COLA). This feature will adjust your payouts for inflation. It is definitely a good feature to include given the fact that over the long run inflation can damage the value of your payout.
When buying any annuity, fixed or variable, be careful about the dates specified within the annuity contract. If you withdraw before the specific date, detailed within the annuity contract, there may be fees assessed. These early withdrawal fees will vary per annuity company and product. So be sure to read the fine print; as you would with any investment contract.
Unlike fixed annuities, variable annuities are exposed to market risks because the annuity company invests your money in the market. Variable annuities invest in “sub-accounts” which are like mutual funds. The market risk causes the principal and earnings to fluctuate with changing market conditions. When the market is up, the value of the variable annuity is up, similar to how a mutual fund would respond to the market. When markets are down, your annuity value is also down. Your rate of return does vary throughout the life of your annuity contract.
The guaranteed lifetime stream of income is still offered with a variable annuity, but this only occurs if and when you annuitize the contract. Annuitizing an annuity contract means converting your investment contract into periodic income payments. Your periodic guaranteed payments will also fluctuate with the market.
Variable annuities typically have a “return-of-premium” death benefit built into the contract. This feature pays your beneficiary at least the amount you originally invested if you should die before you start withdrawals. Before investing in a variable annuity be sure to read the prospectus, this will give you all the details you need to know about your annuity investment.
As the name says, deferred. With this type of annuity contract you are allowed to defer your withdrawals until you the time you choose to start making them. Your earnings will grow tax deferred until you start withdrawals. At withdrawal, the earnings are taxed as ordinary income.
Timing is everything. With this type of annuity contract, your payouts start right away, in other words “immediately”. The annuity company is guaranteeing you a stream of lifetime income, immediately. The company cannot do that if you have access to the principal. So you do lose access to the principal once you put money into an immediate annuity. The annuity company locks down your principal, so to speak, which is why timing is everything. Just make sure the start of your payouts coordinates well with your time frame.
Are You Ready To Buy Annuities?
When annuities are properly used as a financial tool, they can add value to a portfolio plus some financial security. Remember, one of the best features annuities offer that stocks, mutual funds or bonds do not offer is the guaranteed stream of lifetime income feature. The purpose of this benefit is to help ensure you do not outlive your money. Annuities are not for everyone though so before investing, do your research. Make sure you understand all of the features and benefits of annuities before you invest in one. A big financial regret would be to lock into a schedule of periodic payouts and later find out that it does not work for you. Get help, talk with your financial advisor before you buy.