Many people think guaranteed income when they think about retirement income, which ultimately leads to annuities. Annuities — products sold by insurance companies that pay a fixed payment to help you better manage your lifetime income — are one of the most misunderstood investment vehicles, however. They have their place in your investment portfolio, but they should not take up a substantial piece of the pie.
Here’s a look at everything you need to know about annuities so you can get a firm grasp on the perks and downsides before investing your financial resources in them.
Annuities vs. Other Investments
Once purchased from an insurance company, your annuity will provide you guaranteed income for life. There are many choices when deciding on an annuity, though. A few facts to keep in mind:
- You can purchase annuities that offer immediate or deferred payments, depending on your retirement needs.
- You can also choose to have an annuity payout for a specified time period, instead of the rest of your life.
- Annuities can be fixed or variable.
- A fixed annuity will pay you regular payments.
- Variable annuities will pay you higher payments if your annuity investments rise.
- Conversely, variable annuities will also pay you less if your investments fall.
Life insurance is the most common comparison to annuities, but there are key differences. Life insurance is purchased from an insurance company and pays out to survivors of the person who passed away. Annuities deal with longevity: You are essentially betting that you will live longer, so you want guaranteed income over a longer period of time.
Types of Annuities
There are many types of annuities from which you can choose. The products provide guaranteed income, but each type represents a different way to get those funds. Here are some of the most important types to know:
Fixed Annuity
When an insurance company sells you a fixed annuity, it guarantees you a fixed payment at a future date. Fixed annuities often hold safe investments which provide a lower rate of return but more stability.
Variable Annuity
Variable annuities are subject to market fluctuation because they are made of higher risk securities like mutual funds. You have input in the mutual funds chosen so you can reduce your risk, but that might also reduce your return. Variable annuities have payments that fluctuate based on the market, so this type of annuity is generally best for more experienced investors.
Immediate Annuity
Payouts of your annuity funds can also vary based on the type you choose. Immediate annuities pay you as soon as you have made the lump sum payment to the insurance company. An immediate annuity can be either fixed or variable.
Deferred Annuity
Deferred annuities begin payouts at a later date. Though you make a lump sum payment right away, your payout begins in the future. The benefit here is that your money has time to grow, much like a 401(k) or your Roth IRA Basis. Over time, your annuity can grow and result in larger payouts in the future. Deferred annuities can be either fixed or variable.
Each of these types can provide you with different retirement annuities and guaranteed income. A deferred variable annuity gives your initial investment time to grow before you take payouts, for example, but your money is subject to market fluctuation so you may end up with less stable payouts. Choosing an immediate fixed annuity means you know exactly what your payments will be, but your money may not last as long because you have not given it time to grow.
When making your choice, consider:
- Fees charged by the insurance company
- Fees charged by securities and equities your annuity holds
- Surrender fees
- Tax deferred growth
- Your personal longevity
The important thing to remember is that you need to get started with your annuity as soon as possible to give your money a chance to grow. Having those funds will be key to making sure your guaranteed income payments are enough to sustain your lifestyle in retirement.
Determining Whether Annuities are Right for You
An annuity has some advantages in the right situation, but you must be aware that it might not be the best long term solution for you. Consider these factors when determining whether an annuity is right for you:
- Fees associated with your annuity
- A monthly amount you need to live
- Whether you own a business
- Your retirement portfolio diversification
- Whether you want a beneficiary to receive income after your death
- Potential inflation
Each of these considerations is important in determining whether an annuity is right for you. Adding one to your investment portfolio has advantages if you are otherwise well diversified, but deciding which type is best for you can be overwhelming and confusing.
Partner with a Tax Advisor and Start Planning for Retirement
Understanding the nuances with a retirement annuity and deciding which option is best for you can create confusion and uncertainty. It’s an important decision and you deserve clear answers to help you make the informed and educated choices that will help you maximize your lifetime income.
Working with an experienced tax advisor can get you the clear guidance and understanding you need. If you’re looking for answers to your annuity-related questions, contact Silver Tax Group today. Our tax advisors are ready to help you see the bigger picture of how an annuity fits into your overall investment plan and estate plan.
Give our team a call to speak with an expert about your overall investment strategy or for tax planning advice to minimize your future tax burden on potential retirement taxes.
