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Are Annuities a Good Investment? Buy Annuities for Guaranteed Income

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Why Do We Prepare “Are Annuities a Good Investment? Buy Annuities for Guaranteed Income”?

Are annuities a good investment? Well, if you buy them for the correct reasons, they could be.

You can buy annuities for safety, income or long-term growth. For example, fixed annuities may be an excellent alternative to a Certificate of Deposit (CD). Or you may purchase variable annuities for tax-deferred, long-term growth. You can also buy immediate annuities for income purpose. In all these cases, the insurance firm issuing the annuities insures some part of the outcome.

There’re many cases where they insure the portion of the income you can take from the annuities.

The only actual way to find if annuities are a sound investment is to have a plan. Your plan must command your investment goals. It should tell how you how to make decisions to help you reach those goals. If you wish to insure part of the outcome, annuities may be a decent choice.

What Are Annuities?

Annuities are an insurance contract. For many people annuity is an investment. But, when you buy an annuity, you’re purchasing an insurance policy. You’re making sure an outcome there.

You put your money in the insurance policy. And the insurance firm gives you a guarantee on how and when you’ll get the money back. Or the interest rate you’ll get your money.

There’re several kinds of annuities, and each works differently.

As there’re so many annuities, it often leads to confusion about what are annuities and its functioning. You may have even heard strong arguments both in favor and against annuities. But, the fact is that it depends on the type of annuities you’re using.

Types of Annuities

Let’s take a look at the five major types of annuities. These include:

  1. Immediate annuities
  2. Fixed annuities
  3. Indexed annuities
  4. Variable annuities
  5. Deferred annuities

We shall now look how each type works.

Immediate Annuities

Under this, you give the insurance firm a lump-sum amount of money. They will pay you a fixed amount of monthly income. You get this income either over a set period or during your whole life.

Think of immediate annuities which pay out over your whole life like a box of cookies. You give the insurance firm your money (box of cookies). They give you back one cookie every year.

When the box gets empty, they assure you to keep giving you cookies anyway. For as long as you live. In return, you promise that once you provide them with the box, you won’t ask for a cookie anytime. If any year you want four cookies, you’ll have to find some other source. You can’t take it from the box.

Such never-ending supply of cookies means immediate annuities is an attractive hedge against living a long life. Irrespective of how long you live, you’ll always get a cookie every year. Also, you may spend your other income early in your retirement years, but you’ll still get a cookie. For old single people, immediate annuities are helpful to ensure that they don’t outlive their income.

Fixed Annuities

Under fixed annuities, you enter into a contract with the insurance company. As per the agreement you get a guaranteed interest rate for your investments. Fixed annuities work akin to a Certificate of Deposit (CD) which bank issues. The difference is that the insurance firms give the guarantee instead of the bank.

With fixed annuities, the interest you collect is tax-deferred. You only pay tax on withdrawing money. If you withdraw interest before age 59-1/2, you’ll have to pay a 10% penalty tax. This is in addition to ordinary income taxes.

The interest rate is guaranteed for a definite time-period, say 5 or 10 years. Once this period finishes, the insurance firm will inform you about the new interest rate. At this point, you have three options. You can continue with the same annuity. Or exchange it for another kind of annuity, or cash it in and invest the money somewhere else. If you cash in, you’ll have to pay tax on accumulated tax-deferred interest.

Most fixed annuities carry surrender fees. So, if you cash it in early, be ready to pay a considerable fee. Fixed annuities are a smart choice for people wanting low-risk investment. This is also a good choice if you’re prepared to leave your money in the contract for a said time.

Indexed Annuities

Indexed annuities are usually known as a fixed indexed annuity (FIA). Hence, it is a form of a set annuity. With this type of annuities, you get a minimum guaranteed return plus the potential for extra returns. It uses a formula which links any increase in your account with a stock market index.

Indexed annuities carry complex features like cap rates and participation rates. These rates determine the formulas for how your returns are computed. Compare these features when looking at indexed annuities. Think of this product like a CD alternative, rather than an equity alternative. If someone suggests it as an equity alternative, think again.

Some indexed annuities also guarantee the sum you can later withdraw during retirement. Such product is deferred indexed annuity. It can be a decent choice for a person who has ten years to his retirement. Hence, it guarantees the sum he’ll get in future.

Variable Annuities

Under variable annuities, you enter into a contract with an insurance firm. You get to pick how to invest the money in your deal. The insurance firm gives a set of funds to choose from. It is named variable annuity as the returns you get is not fixed as per the investment you select. Compare this with the fixed annuities, where you contractually get a fixed interest rate.

Under variable annuities, your investments grow tax-deferred. Hence, you can exchange between investments without the need to pay tax on capital gains.

Variable annuities must provide guarantees to qualify as a contract of insurance.

Death benefit guarantee is the most common guarantee type. It ensures that on your death, your beneficiary will get a certain amount of money. This sum is the higher of the present contract value or the total sum of your contributions. E.g., you invest $100,000, and the investments fell in value to $90,000. You pass away at that point. Then, in this case, your beneficiary will get $100,000. If the investments had increased in value and became $110,000, then the recipient will get $110,000.

The variable annuities of today come with extra death benefit guarantees plus living benefit riders. This makes them one of the most complicated consumer financial products. For investment purposes, index funds are preferable over variable annuities. But for a guaranteed result, other annuities are better. This doesn’t leave several cases where variable annuities are a smarter option. Because of tax-deferral, a variable annuity may be a suitable option for a young high earner. More preferably a person who is already maxing out IRA contributions and 401(k) plans. Such a person seeks an extra place to invest income where it may grow for 20-30 years.

Deferred Annuities

Under this, you put money today and get a guaranteed income at a specific time in future. This future period usually is ten years from the time you buy the annuity. Deferred annuity helps decrease the risk that a significant fluctuation in the stock market would damage your retirement plans.

Many variables, fixed and indexed annuities provide a deferral feature. Through this, you get the choice to buy a set sum of future income. These features have names like:

  1. Living benefit
  2. Guaranteed withdrawal benefit
  3. Guaranteed income riders

Deferred annuities are also known as longevity insurance. There is also a particular kind of deferred annuity, named Qualified Longevity Annuity Contract (QLAC). You can buy this with your IRA or 401(k) money. With a QLAC, your income will start at age 85. So, this annuity ensures that you’ll have a necessary amount of money in old age.

Like you can notice, all annuities are not the same. Any annuities could be an ideal choice if you’re aware why you’re buying it. You should also know how to use it. Hence, any annuities can also be a wrong choice if you’ve no idea how it works.

When Does Annuities Work Best?

There’s no one work annuity does the best. To know what it is, you must understand that annuities come in different sizes, shapes, and types. Ready to take a crash course on annuities? Here we go.

Key Point: All Annuities Aren’t the Same

Do you know the numerous types annuities out there?

  1. Immediate annuities
  2. Inflation-adjusted immediate annuities
  3. Variable annuities
  4. Variable annuities with guaranteed income riders
  5. Deferred annuities
  6. Annuities with long-term care riders
  7. Fixed annuities
  8. Equity index annuities
  9. Equity-indexed annuities with guaranteed income riders

Every annuity type has a range of benefits and features which may suit your retirement plan. Or it may not. All of this depends on what you need to do with your money and what trade-offs you’ll make. Every annuity is different. So, when you hear the term annuity, avoid the stereotype.

Key Point 2: All Annuities Have One Common Feature

Every annuity is an insurance product. They’re policies which the insurance firm issues. If you want to defer some types of risks to an insurance firm, annuities will do it for you.

Transferring investment risk takes place when you get a fixed annuity. The insurance firm takes the amount, invests it and pays you a fixed rate of return. They bear the risk instead of you.

Transferring longevity risk occurs when you get income annuities. It pays you a fixed monthly amount of your remaining life. No need to stress about outgrowing your money. This risk is transferred to the insurance firm. And this is the main feature of all annuities.

Key Point 3: Annuities Are Very Good at One Thing

And that is hedging longevity risk. The risk that you may run out of your money while you’re still alive.

People who don’t want to face this risk can consider the following annuities:

  1. Immediate annuities
  2. Longevity insurance
  3. Single premium deferred annuities, and
  4. Variable annuities having assured withdrawal benefit or assured income benefit feature

Why are annuities so efficient at defending against longevity risk? Due to something known as mortality credits. In any given group of people, some will live longer than others. If you get your annuities when you’re 70 years or above, you may get a higher pay-out. This is something similar to a higher rate of return due to how mortality credits function. It’s another means of getting a potentially higher return. But, many won’t perceive it like this.

Key Point 4: What to Be Careful About with Annuities

If misused, annuities can be expensive and restrictive. You should always remember that annuities are a tool. That’s about it. If you speak with an annuity seller, they’re going to detail the benefits of their instrument. But, if you talk to someone who isn’t making money selling annuities, they’ll tell you why not to buy one.

If you speak with a financial advisor, they may help you determine if the chosen annuities would be beneficial. They’ll also help you contrast it with other choices.

When Are Annuities a Good Investment?

Firstly, annuities are an insurance product. This means you buy it to lessen your risk. Annuities like variable annuities have many bond and stock portfolios as investment options in the contract. Others are real insurance without any investment element.

There’s one thing which annuities do well. It offers a hedge against the risk of longevity. Hence, if you buy annuities, for this reason, it could be a sound investment.

Annuities may be the ideal investment option if you’re aware of your retirement goals. If you know how the annuities can help you reach those goals, go for annuities. Plus, it’s also ideal for you if you understand the restrictions and fees of annuity products. You must know how the tax is charged on the annuity income, and the investment choices available. It’s also important to understand how the annuities fit with your other investments.

When Are Annuities a Bad Investment?

Don’t fall for someone trying to sell annuities without knowing your real financial picture. Many people who sell annuities do mean well. But, they might not possess a complete understanding of the products they sell. Plus, they usually don’t have a sound grasp on tax consequences. Besides, if they haven’t planned your financials, they can’t look how the product will match your retirement plan.

We’ve seen salesmen say, “How does the fee matter if it is doing what you desire?” We don’t agree with this statement. High fees decrease your returns. Such high fee in variable annuity products implies that in anywhere but the best markets, you’ll earn low returns.

Don’t buy any annuities unless you have a plan and know how the annuities fit in. Annuities aren’t going anywhere. So, there must not be any urgency or pressure to buy until you’ve done your research. Some sales reps will try to influence you by saying that the product is available for a small period. This may be true because insurance firms discontinue the products quite soon. But, don’t worry. A similar product with more or less the same features will come fast enough.

Annuities Differ from One Another

There’re many types of annuities. Each one has its merits and demerits. It’s important to understand the different types of annuities. Only then can you ask questions about the annuities you may be considering.

Compare no-load annuities with broker-sold annuities before buying. No-load annuities have low fees as you can buy them directly. But, you should do your complete research before buying them. This is the trade-off between paying a lesser fee. Some fee-only advisors can help you choose a suitable no-load annuity if it matches your plan. People who have an insurance license sell the broker-sold annuities. They may also have a securities license.

Do your research and review options for annuities before making the final call. You may also want to ask about annuity fees.

Any reputable firm or advisor must tell about the costs before they sell. If they’re not ready to explain their product fees, don’t buy from them. They should also explain how they get compensation from the product sale.

Conclusion

So, who should buy annuities? In many surveys, potential retirees claim their main fear in retirement is not having money. An immediate annuity is an ideal choice to safeguard against this possibility. And still very few buy annuities.

Why is it so? This doesn’t make any sense. We feel that people don’t understand the products. Honestly, we also think many people think their lifespan is not so long.

This is not me. I am spellbound by the world and the things we do. And, I want to experience as much as I can. Thus, annuities are a good option for me.

What is your view on annuities? Hope this article can help to make the right investment decision, make more money, get rich and become a millionaire! Please feel free to share your view with us.