No investment or insurance strategy is more polarizing than annuities.
Some financial professionals love them. Some hate them. Others claim to hate them — but only certain kinds. All of which is extremely confusing for the average investor.
The bottom line is that annuities can be a wonderful tool for those looking to generate guaranteed retirement income. They also can be a real headache if used improperly or if you’re sold one as a stand-alone solution rather than as part of an overall investment plan. Plus, they can be complicated. The contracts can be dense, inflexible and littered with legalese.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Types of Annuities
To add to the complexity, there are several types of annuities, each with its own pros and cons, depending on an investor’s specific needs. They include:
Immediate annuities: In exchange for a lump sum payment (or premium), an insurance company promises to immediately begin making regular income payments to you for a chosen length of time (usually five years to life). The amount of your payment will vary based on your age, gender and the length of the term selected. When you annuitize, you are giving up the principal and only have rights to the future income.
Fixed annuities: These are a lot like a certificate of deposit (CD) in that you give an insurance company a lump sum of money, and they offer you a fixed rate of return over the agreed-upon time period. Like a CD, if you need to make an early withdrawal during that time, there could be a penalty.
Variable annuities: These are often described as mutual funds wrapped in an annuity contract and purchased through an insurance company. The investment options are referred to as “subaccounts,” and just as when you invest in your 401(k) or brokerage account, you can choose to be aggressive, moderate or conservative. Your account value benefits from the upside of the markets, but it also is vulnerable to market losses.
Fixed index annuities or equity index annuities: These “hybrid” annuities act almost as a combination of fixed and variable annuities. They have the principal protection of a fixed annuity but also some upside potential because of their ability to earn interest based on the performance of the index to which they’re linked, such as the S&P 500.
Obviously, these are very brief descriptions. If you are truly interested in evaluating what an annuity could do for you, you’ll benefit from some research into specific products and an in-depth conversation with a financial professional before making a purchase.
3 Tips When Considering Annuities
Here are three things to keep in mind as you move forward:
- Know the costs. Annuities have all sorts of customization options or “riders” that can be attached to a contract to expand or restrict a policy’s benefits. These can guarantee a lifetime income without having to annuitize, add long-term care features, enhance the death benefit and much more. These options almost always come at a price — and that’s on top of the base contract costs. They can add up, especially for a variable annuity, which typically has subaccount fees, administrative costs and mortality costs built into the base policy.
- Understand the timeline. It’s never wise to put funds for shorter-term needs into an annuity. Make sure you maintain adequate liquidity to deal with daily and unexpected expenses, as annuities typically charge hefty penalties for violating early withdrawal terms. Also, be aware of the liquidity provisions, as some annuities offer one free annual withdrawal, allowing you to take out a specified amount that isn’t subject to penalties.
- Understand the risk and growth potential. You can’t expect to match market growth using fixed or fixed index annuities, and you can’t expect protection from market losses from a variable annuity. While a variable annuity can match market returns, fixed or fixed index annuities act more like a bond component of a retirement plan.
When you’re ready to speak to a professional about purchasing an annuity, it’s important to find an experienced, unbiased adviser licensed in both securities and insurance, preferably with a CERTIFIED FINANCIAL PLANNER™, Chartered Financial Consultant® or Chartered Life Underwriter® designation; who acts as a fiduciary; and who represents multiple insurance companies.
Annuities aren’t evil — they’re just another tool that may or may not fit within your financial plan. Because they’re complex, it’s easy to make mistakes. Proceed with caution and be sure you’re getting the best advice from someone you can trust.
Kim Franke-Folstad contributed to this article.
-
Dow Hits New Intraday High on Fed Day: Stock Market TodayNot even the most important stock in the world could keep the oldest equity index down on a significant day for markets.
-
Savings Goal CalculatorTools Want to know how much you need to save each month to reach your financial goals? Our calculator helps you build a realistic savings plan.
-
Gray Divorce Can Throw Your Retirement a Curveball: What to KnowIf you're entering retirement and going through a divorce at the same time, you've got some work to do to shore up your long-term financial security.
-
I'm a Real Estate Investing Expert: Optional 721 UPREIT DSTs Can Be the Best of Both WorldsBefore investing in any 721 UPREIT exchange, look for one that offers a straightforward, investor-friendly exit.
-
How an Expired Passport Thwarted Blackmail (and What Other Important Documents You Should Keep)An optometrist produced his expired passport to foil a blackmail attempt by the daughter of a former employee. After proving he was out of the country on the date of a forged diary entry, he took it a step further.
-
Optimize, Grow, Retain: The Power of Annual Client ReviewsFinancial advisers can use annual reviews to help enhance client outcomes, strengthen relationships and build their practice.
-
I'm a Real Estate Investing Pro: This Is What Investors Should Know About Truck Stop InvestmentsTruck stops might seem like good investments, but they can actually be a risky gamble due to unstable fuel prices, unreliable operators and coming changes in transportation. Instead, consider safer options like industrial or residential properties.
-
Don't Disinherit Your Grandchildren: The Hidden Risks of Retirement Account Beneficiary FormsStandard retirement account beneficiary forms may not be flexible enough to ensure your money passes to family members according to your wishes. Naming a trust as the contingent beneficiary can help avoid these issues. Here's how.
-
This Is How Life Insurance Can Fund Your Dreams NowBeyond a death benefit, life insurance can provide significant financial value and flexibility through 'living benefits' while you are still alive, helping with expenses like education, business ventures or retirement.
-
Potential Trouble for Retirees: A Wealth Adviser's Guide to the OBBB's Impact on RetirementWhile some provisions might help, others could push you into a higher tax bracket and raise your costs. Be strategic about Roth conversions, charitable donations, estate tax plans and health care expenditures.
