Complicated. Expensive. Unnecessary. These are just some of the ways that the general public perceives annuities. In truth, they are far more accessible and useful to workers of all ages than urban legend dictates. As with all investments, the trick is to have clarity on your financial goals and to shop around for the plan that fits those needs.
At their most basic level, annuities are contracts sold by life insurance companies and are most often used as long-term investments suitable for retirement. They are designed to accumulate tax-deferred wealth and can grow before and after retirement. They can also provide protection against a downturn in the market and a cushion should you outlive your savings.
Below, we explore five common myths associated with annuities and provide insight into why annuities might be the right investment vehicle for you.
1. I’m too young for an annuity.
Contrary to popular belief, annuities are a great option for saving and perpetuating long-term retirement income, as workers of all ages have discovered. The various types of annuity generally break down into two categories:
Immediate annuity. With this type of annuity, you deposit a lump sum and can draw income right away.
Deferred annuity. With a deferred annuity, the insurance company pays out in the future at a higher rate. This vehicle is particularly useful if you have reached the contribution limit for your 401(k), 403(b), IRA, or other employer-sponsored savings plan.
Deferred annuities come in two main types (note that both limit withdrawals before age 59½):
Deferred variable annuities, which function in a similar manner to mutual funds. You are typically permitted to make unlimited contributions, and you have full control over how your money is invested.
Deferred fixed annuities, which work in much the same way as a certificate of deposit (CD). They guarantee you an interest rate that is locked in for a specified period, usually from one to 10 years.
2. Annuities are too expensive.
Annuities come in a variety of price points, and your cost will correspond to the features you find most valuable in order to accomplish your financial goals. Do you want to create income? Accrue savings? Both? These require different tools and are priced accordingly. Annuities offer some unique options, which include income guarantees, tax deferral, and a guaranteed minimum death benefit. When it comes down to it, only buy what you really need.
Costs can also vary depending on how you use the annuity. Small withdrawals, usually up to 10 percent, typically have no fees attached. If you need to pull out a large portion of your money during the life of the annuity, you will likely encounter a “surrender charge” for early withdrawal. And many annuities have options to liquidate in case of major life events, including nursing care or a terminal illness.
3. Annuities are only for those who are retired.
Before you reach retirement age, annuities can protect future income from swings in the market and even inflation. Consider these options, which may put your mind at ease and increase the nest egg awaiting you:
Deferred income annuities (DIAs) are meant to provide guaranteed future income for life, independent of any market volatility. You select the date when payments begin, locking in future cash flow. They also offer a cost-of-living adjustment (COLA) which helps prepare for inflation.
Fixed deferred annuities with a guaranteed lifetime withdrawal benefit (GLWB) rider allow more flexibility to manage the investment but may provide lower payments. They provide guaranteed lifetime income that corresponds to the age at which you begin withdrawals. Wait a little longer, get a little more.
4. My retirement accounts already have me covered.
Annuities are one of the handful of guaranteed income sources—alongside pensions and Social Security—that last a lifetime. Retirement security ultimately relies on answers to two big questions: How long will you live? How strong is the market? If the market doesn’t behave, you could find yourself out of money far earlier than expected.
There are solutions to help weather any potential storm:
Limit withdrawals from your retirement accounts to 4 percent a year, adjusted for inflation.
Have an emergency fund at the ready in case of unanticipated costs.
Create a retirement budget that considers all income sources, such as Social Security, pensions, and other investment vehicles.
Invest in an annuity, which is immune from market fluctuations and requires no maintenance.
5. When I die, the insurance company gets it all.
The majority of deferred annuities, and some income annuities, will pass the remaining value of the account on to your beneficiaries. You can also make arrangements for the unforeseen possibility that you pass away prematurely, though this may involve additional costs.
The main exception to this is if your annuity is designed for life-only payouts. In this scenario, you would receive larger payments during your lifetime, but the balance would then pass back to the insurer. Ask if your plan includes a beneficiary agreement that would allow your heirs to receive the outstanding balance. Some providers include this feature; some charge an additional fee.
In sum: Annuities are worth your consideration.
Annuities are flexible options that can provide a reliable source of retirement income, and each type is intended to apply to a particular stage of life or financial need. Before you sign on the dotted line, be sure to research a company’s rating and consider scheduling a free consultation with one of our wealth advisors.