Do Annuities Make Good Investments? What to Consider Before Purchasing
Do annuities make good investments? How are they used for retirement income later in life?
What is an annuity?
An annuity is a type of retirement savings vehicle usually offered through insurance companies and, in one way or another, guarantees a steady income after you retire, whether in monthly, quarterly, or yearly pay-outs.
There is various type of annuities, including:
- Fixed or variable
- Deferred or immediate
- Period certain
- Lifetime
- Joint/survivor
While these conditions can be combined to produce your own personal cocktail of retirement requirements, the attributes which make the largest difference are: whether or not you’ll be receiving payouts immediately or later on, and whether you prefer a guaranteed payment amount or a sum based on stock exchange performance.
If folks talk about annuities, they’re certainly talking about deferred annuities. It is reported that around 90 percent of those annuities sold are deferred annuities rather than immediate annuities. Let us cover that.
How do deferred annuities differ from other investment accounts?
Deferred annuities share common traits with other retirement options, such as 401Ks and IRAs, in that they allow you to set aside money for retirement on a tax-deferred or tax-free basis.
There’s also no limit on how much money you can invest in an annuity, unlike the caps that are placed on other options.
Sounds awesome right? This is often touted as one of the key benefits of an annuity, but there are downsides on the tax front too. Annuity payments are taxed as ordinary income at ordinary income tax rates, not the preferred capital gains tax rate.
What are the advantages and disadvantages of a deferred annuity?
Deferred annuities are helpful for three reasons.
- If you’ve already maxed out your investment ceilings in 401Ks and IRAs, then you are able to put more money into policies for tax-free growth.
- There is a large surrender fee, which assists many people to save because they are reluctant to take money out for wasteful spending.
If you’ve already invested in a deferred annuity, you can change the terms to an immediate once you decide to begin withdrawing money. Those who need a guarantee of earnings for a spouse or determined after they’ve expired will also be attracted to annuities based on their choices for guaranteed payments inside a predetermined year range or even for your lifetime of the survivor.
These features make them similar to a life insurance policy in some respects.
The first bad news you’ll hear about annuities is their expense-to-benefit ratio. Annuities, or more especially, deferred annuities, are sold by insurance companies whose brokers receive up to 10 percent commission on annuity earnings, and up to 3 percent yearly maintenance fees.
Should you withdraw within the first 7-8 years of buying an annuity, you’ll probably be subject to a surrender charge, very similar to the early withdrawal penalties related to 401Ks and IRAs as well.
What’s more, if you choose a variable rather than a fixed annuity, you run the risk that the investment performance won’t outpace the high fees you’ll be charged for it.
Are there alternatives to annuities?
The most important advantage of annuities is that their capacity to provide immediately and establish income throughout retirement; even if you’re at the place in life where you require security and dependability, then the advantages of this option may outweigh the advantages.
Otherwise, in case you’ve got some time to go before you retire, think about mutual or index funds — investment accounts that carry lesser annual feeds and might yield more cash while you don’t mind the risk.
What about Single Premium Immediate Annuity?
I know I just made annuities sound pretty bad, but not all of them are disastrous. 1 such choice you should consider is the only premium immediate annuity (SPIA).
You hand over a lump sum, and you are then guaranteed to be paid a monthly payment for life. It is almost like getting a job, only that you’re a) buying the income flow instead of doing work, b) you will not be getting promotions and thus a big jump in income as you aren’t getting any performance reviews, and c) you are guaranteed to not be terminated unless the insurance company goes under.
On the previous time, the state government will take over the annuities and pay out the claims when an insurance carrier goes into liquidation. There’s a limit that varies by state though, so it is best to look up that limit for your state and spread your risks to several distinct companies if you’re buying this kind of big policy which it is going to be higher than the authorities guarantee.
Why would I want an SPIA?
There are a few advantages to purchasing an SPIA. For one, you don’t have to think about fees because the earnings you’re quoted is currently net of charges. This implies that whatever monthly payment you agree to will be the payment you receive each month. The main benefit of an SPIA though is that you can offload your wellbeing risks to the insurance provider just if you’re fortunate enough to live a long life. This might be a win-win for you and the insurer because the insurance company can pool the dangers from several different policyholders while you don’t really have that luxury.
What are the different options?
Immediate annuities are fairly straightforward but there are still several variants you want to decide in the get-go. Do you need your partner to be contained in the coverage (meaning the mortgage will continue paying before the departure of both spouses)? Would you desire the monthly payment to be corrected for inflation over time? That is 1 aspect, an annuity can’t guarantee.
Another is if your insurance carrier may go under. A lot of folks would say to inspect the credit ratings of insurance companies and be sure that you make the coverage from the most fiscally sound institution. As you certainly need to obtain a policy that is from a respectable insurance provider, I am not certain whether the credit bureaus will do so much good. Did anyone believe AIG was planning to go under? Were they perhaps not an exceptionally reputable and apparently good firm? Nevertheless, it surely would have gone into the financial crisis if the authorities had not stepped in and taken over.
That is why the sole method to limit your vulnerability is to become many coverages from various companies in the event the quantity under consideration will be greater than the state warranty limitation.
The odds of insurance firms moving below are slender, but it is not zero.
