Annuities are a product offered by insurance companies. Annuities pay out income, and are often used as part of a retirement strategy. They’re a good choice for people who want a steady stream of income throughout their retirement.
Annuities are based on investments. The buyer makes an investment in the annuity, which pays out on a future date or a series of future dates. Income received from an annuity can be received monthly, quarterly, annually, or even in one single lump sum. Naturally, the size of an annuity payment depends on several factors, including how long you’ve paid into the annuity.
Whether you opt to receive annuity payments for the rest of your years, or for a fixed term, such as 10 or 20 years, you will need to choose between a guaranteed or fixed annuity and a variable annuity. Fixed annuities pay out a given amount, while variable annuities are based on performance of the investments that form the annuity.
Advantages of Buying Annuities
The most significant advantages offered by annuities are the tax advantages. Buying an annuity allows you to defer paying taxes. But unlike other retirement savings plans, annuities do not have an annual contribution limit. That means that if you are close to retirement age and need to play catch-up with your retirement fund, an annuity is a good option. Everything that you invest will compound tax-free year after year—a sizeable advantage compared to other taxable investments. When you cash your annuity, you can choose how frequently you want to be paid. For many retirees, having a guaranteed payment for a given length of time is reassuring. Most of the time, annuities serve as a supplement to other sources of income during retirement, including social security and pension plans.
Disadvantages of Buying Annuities
While annuities do have some advantages, they can be costly as far as investment choices go. Firstly, annuities tend to involve a high commission. Sold by insurance brokers and often suggested by financial planners, the commission is usually around 10 percent. Next, having to pull money out of your annuity will cost you. Surrender charges for annuities are often around seven percent of the value of the account if you leave after only one year, though the cost tends to decline by one percent each year. However, certain annuities have surrender fees as high as 20 percent for the first year. Finally, annual fees for annuities are high, especially where variable annuities are concerned. Annual charges may be around 1.25 percent, while management fees can range from 0.5 to more than two percent. Insurance riders, too, can mean fees of around 0.6 percent annually.
How to Buy an Annuity
You need to find a licensed insurance broker to sell you an annuity. Advisors and financial planners usually cannot legally sell you an annuity unless they have a broker license. You have the option to contact an independent annuity broker or find an agent through an insurance company. However, it’s important to make sure you get a quote that’s competitive and look into other options.