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Investing 101

Buying Annuities

August 29, 2019


Retirement comes with worries if you’re not financially stable. In such a situation, the safety that a guaranteed income offers seems to be the most important thing. And annuities can be one of those sources that promise a constant income stream you cannot outlive. This guaranteed income is provided by an insurance company and is considered a long-term investment.  

Many finance experts believe that annuities are a flexible choice that enables people (mostly retirees) to invest an amount for some time. What makes annuities different from other investment options is their quality of providing immediate payments. That means the investor can start receiving funds or payments whenever he/she needs them.

If you are looking for a reliable way to save money for your retirement age, investing in annuities might be a good option. 

Here we break down the essential information related to investing in annuities to help you make a well-informed decision.

What is an Annuity?

An annuity investment is a contract between an insurance company and an investor. The contract requires the insurance company to make payments for the policy buyer either immediately or later in the future. An investor may buy an annuity with a single payment or multiple installments. Similarly, the payout to the investor comes as either a single payment or a series of many payments over a course of time.

In other words, the annuity contract has specific goals that often include legacy planning, principal protection, and lifetime income. The insurance companies market annuities as investments, but they are different from investments. They are more like a contract that locks investors and insurers into a contractual obligation. If the insurer tries to break them, that may cost high charges.

Although annuities have been around for a long time in the US, they have gained popularity in the past few years. The increased volatility of the financial markets has endangered many retirement plans. Many retirees opt for annuity investment to replace their income stream as it provides guaranteed income unlike other investment plans for the rest of the investor’s life.


Why do Investors Buy Annuities?

Annuities are purchased to manage retirement income. They provide the following

  • Death benefits – annuities allow beneficiaries to receive payments if an investor dies before he/she starts receiving them.
  • Periodic Payments – this benefit is for the rest of an investor’s life or the life of his/her spouse.
  • Tax-deferred growth – until the investor withdraws the money, he/she does not need to pay investment gains or taxes.

Types of Annuities

Annuity investments are of three types that include:

· Fixed Annuity

This is one of the types of annuities that offer excellent growth potential. In fixed annuities, the insurance company provides a fixed amount of payments periodically, along with a minimum interest rate. State insurance commissioners regulate fixed annuities that let retirees save money with tax deferral and death benefits for the beneficiaries.  Moreover, fixed annuities can protect your savings from the ups and downs of the market with some great guaranteed rates.

· Variable annuity

This is a type of annuity in which the insurer allows an investor to direct annuity payments to a variety of investment options, especially mutual funds. It may change the payout of the investor as it depends on how much he/she puts in, the expenses and the return on investments. Variable annuities are regulated by the SEC.

· Indexed Annuity

This type of annuity is a combination of insurance products and security features. The insurer basically credits the investor with a return based on the index of the stock market such as the S&P 500 Index. An indexed annuity is regulated by insurance commissioners.

Pros & Cons of Annuities

With each of this annuity type, you can pick annuity and immediate annuity, and supply the insurance company with an amount to immediately begin periodic payouts. However, like all investments, annuities also carry a certain level of risk. Let’s take a look at the benefits and risks they carry.

Benefits of Investing in Annuities

  • Receiving regular payments is one of the basic features annuities, and also a big benefit. The payments are like supplemental income after retirement and help people cover their regular expenses.
  • The money people invest in buying an annuity is tax-deferred. That means investors pay money before they pay taxes.
  • Money that is put in annuities has a guaranteed return (at least a certain  percentage)
  • Variable annuities offer a perk of the death benefit. An insurance company is bound to make payments to the beneficiary

Risks of investing in Annuities

  • Annuities can be expensive. When signing a contract, it is important to understand the cost structure of the type of annuity you choose and the personal goals.
  • With annuities, an investor is committed to a contract that comes with a “free look” period. Once this period is over, the investor is barred from his/her principal refund.
  • If the chosen insurance company does not have good financial foundations, it may risk your future income.

Buying Annuities – FAQs

  • What does tax-deferred status refer to?

Tax-deferred refers to a status where there is no interest on the savings until they are withdrawn. This status helps annuity holders increase their earning amounts.

  • Can annuities be sold?

Yes, an annuity can be sold if annuity holder has any financial emergency such as a debt or medical expenses.

  • What happens to an annuity when annuity holder dies?

Investing in annuity provides death benefits. That means if an annuity holder dies before annuity disburses payments, the assets are transferred to the surviving beneficiary.

  • Is there any Fee associated with Annuity?

The fee of annuity varies, depending on the type annuity you are investing in.  The common fee structure includes:

  • Mortality and Expense (M&E) fee
  • Administrative fees
  • Investment management fee

Key Takeaway

Annuity investment is a financial contract that typically benefits retirees. It pays out income in exchange of monthly payments or a lump sum toward the principal. There is no denying that it is an excellent way to opt for a guaranteed income throughout life.

 

Sources

https://www.annuity.org/annuities/faqs/

https://www.investor.gov/introduction-investing/basics/investment-products/annuities#Benefits

https://smartasset.com/retirement/pros-and-cons-of-annuities

 

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