How To Not Outlive Your Money – An annuity normally provides a yearlong or lifetime stream of income, akin to Social Security. The insurance company behind a lifetime annuity carries the risk that you will go on living well into ripe old age. If you expect to be healthy and active, you might want to take that bet.
Annuity flavors and how they work
There are three basic annuity types:
- Fixed.
- Variable.
- Indexed.
The return on a fixed annuity is predetermined for either life or a set number of years. Rates are often similar to those on CDs but can reset every few years or so. They may depend on your age, your gender and the market rates at the time you make the purchase. Women often earn a smaller income stream than men because actuaries know that women tend to live longer. Although payback rates are modest, guarantees do ensure you will at least make some percentage of your original investment.
Annuity products work best for retirees with long-term goals who do not need immediate access to their funds. Typically, you must leave your money for about two to 10 years in set period annuities. Life annuities earn the most, but be careful not to tie up too much money and to save some reserve funds for unexpected expenses.
Variable annuities depend on the performance of stock or bond subaccounts, so you will be at the mercy of the markets. They are likely to appeal to younger purchasers, who have more years ahead to ride out volatility. Income riders, though, may guarantee variable holders a minimum income for life.
Indexed versions are based on a specified index such as the S&P 500 and share common features of fixed and variable instruments. The funds are not directly invested in the index but instead mirror its returns. Some also limit payouts using participation or cap rates, which restrict the annuity holder’s own return to a percentage of the index.
Holders of immediate annuities can begin to collect payouts from the moment they are funded; deferred products start yielding returns at a certain future date. To protect the holder’s heirs in a situation where the holder passes away unexpectedly during the accumulation phase, while their funds are still exiting and not yet coming back, most contracts offer a death benefit to be paid to a named beneficiary.
On the bright side
There are several compelling reasons to allocate some of your retirement nest egg to an annuity, as long as you do so judiciously:
- Holders cannot outlive the income stream if the period is for a lifetime.
- No taxes are payable until funds are withdrawn (unlike with CDs).
- Fixed annuities are cheap, with no annual fee and limited expenses.
- Joint and survivor options may be available for a spouse, or specified period options for a non-spouse beneficiary.
- Inflation protection or principal protection riders may be added.
- You can roll over qualified savings, like a 401(k) or an IRA, into a qualified annuity without incurring tax penalties.
- Since you cannot access all the money upfront, you cannot accidentally spend or gift away too much.
The downsides
On the other hand, watch out for significant drawbacks:
- Internal expenses of variable annuities can be complex.
- Surrender charges for an early exit may amount to over 10% of the contract.
- Annuities depend on the solvency of the insurance company, with only state guarantee assurance for backup.
- They may be more expensive compared with mutual funds, CDs or robo adviser-selected stocks.
- Upfront sales commissions may be chargeable (unless you buy directly from an insurer).
- You cannot withdraw funds from an immediate annuity.
- Other variable annuity fees may apply, such as administration, mortality and expense risk.
- After purchase, inflexible payments cannot be accelerated or altered.
Annuities can play a valid role in a retirement portfolio, especially to supplement other income. Be sure to discuss all the pros and cons beforehand with your financial advisor.
Copyright, 2023
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