What is an Annuity?
An annuity is a financial instrument that provides guarantees toward lifetime income or capital preservation in exchange for a lump-sum deposit for a specified period of time – life in most cases, and a surrender schedule that decreases overtime.
Annuities are classified as immediate or deferred:
Immediate annuities offer the highest payout in exchange for keeping your money if you die. For example, if you die the month after receiving your first check, the insurance company keeps the difference. You can guarantee your spouse or beneficiaries income or a lump-sum payout for a reduced monthly payment. See cash refund, joint-life, period certain.
Deferred annuities offer fixed, index, or variable investment options and grow tax-deferred until you choose to begin distribution, hence deferred. They typically offer a minimum guaranteed death benefit equal to your initial investment minus withdrawals. These accounts are popular for their guarantees, flexibility, and add ons called riders.
Deferred annuities have multiple investment options:
A fixed investment is a guarantee from the insurance company to offer a competitive current rate of interest, and a minimum guaranteed rate of interest the insurance company can not adjust below, usually in low interest rate environments.
An index investment offers the potential for stock market returns with the safety of a fixed account as you cannot lose money. With an index annuity, you’re not actually invested in the stock market. Instead, your account is tied to an underlying index fund, like the S&P 500. Positive and negative performance are averaged over a selected period of time, usually 1 year, and credited to your account if positive.
A variable annuity represents a direct investment in the stock market, offering it’s participants the highest potential for returns out of all three options. Because you’re directly tied to the stock market, you CAN lose money.
Who should buy an annuity?
Annuities guarantees are particularly attractive to those retiring, or who have already retired, because they do not have the time to rebuild after significant market crashes, and cannot afford to take hits while making withdrawals.
The guaranteed income from an annuity is traditionally combined with Pension and/or Social Security to replace what was once received while working for an employer. This gives retirees the ability to focus on enjoying their retirement instead of worrying if the stock market will return a successful retirement. Keep in mind, many annuities do not offer much income stream growth potential after they’ve been activated.
In essence, if you’re a risk-averse who prefers guarantees during retirement, and annuity is probably right for you. If you’re hands on with your investments, or have enough assets to speculate during retirement, an annuity might not be for you.