When it comes to investing in your future, there are plenty of different financial vehicles and investments to choose from. There are stocks, bonds, mutual funds, tax-advantaged retirement funds, real estate, REITs, precious metals, cryptocurrencies, insurance plans, and more. And if you spend any time studying the different options that exist, you’ll also come across annuities.
When it comes to the latter – annuities, that is – there’s a lot to think about. The wrong annuity can be a rip-off, while the right annuity could secure your future by giving you a guaranteed source of income that’s not dependent on market gains. Read on to learn more.
What is an Annuity?
Annuities seem complicated – and, to be honest, many companies make them more complex than they need to be – but they’re really quite simple.
As Investopedia explains, “Annuities are contracts issued and distributed (or sold) by financial institutions where the funds are invested with the goal of paying out a fixed income stream later on. They are mainly used for retirement purposes and help individuals address the risk of outliving their savings. Upon annuitization, the holding institution will issue a stream of payments at a later point in time.”
You can think of an annuity as existing in two stages. The first stage is the accumulation phase. This is where you fund the product with a lump sum investment and/or periodic payments. Once the annualization phase is reached, the product pays out regular sums of money. Depending on how the annuity is set up, these payments may be delivered over a fixed period or for the plan holder’s remaining life.
As a financial instrument, the purpose of an annuity is to provide a reliable and steady stream of cash flow for an individual during their retirement years. It’s typically used alongside other strategies like 401k/IRA investing and Social Security to give people a layered and diversified approach.
Tips for Selecting the Right Annuity
As this article shows, choosing an annuity doesn’t have to be difficult. Here are some helpful tips for zeroing in on the right one:
- Ask Yourself Two Questions
At the very start of this process, it’s important to ask yourself two very specific questions:
- What will I use this annuity for? Are you retired? Planning to retire soon? Looking for a way to create income that can be left to your children or grandchildren? How and when you choose to use an annuity will have a major influence over the type of annuity you go with.
- Will I need this money right away? If there’s a chance that you’ll need to access this money within the next five years, it’s probably not a good idea to invest the funds. Annuities have steep surrender fees that can destroy the investment if you have to withdraw before a certain time is reached.
How you answer these questions will dictate how you should proceed. It’s possible that these answers point you in a direction other than annuities. Or it’ll give an idea of the type of annuity to pursue.
- Know the Different Types of Annuities
Annuities come in fixed and variable varieties. You can also choose between immediate and deferred. Here’s what that means:
- Fixed annuities guarantee a payment for a set period of time. This payment is fixed and will not go up or down (regardless of what the market does).
- A variable annuity can fluctuate based on the returns of the mutual fund. This allows you to earn more when the market does well, while the value can go down if the market crashes. The risk/reward factor is higher with a variable annuity than it is with a fixed annuity.
- Immediate annuities pay out as soon as you make a lump payment.
- Deferred annuities don’t pay out until a future annualization phase is reached. This date is usually chosen by the buyer.
- Buy When Rates are Higher
It’s best to buy an annuity when interest rates are higher. You’ll get a much higher return on your money. If you’d prefer to start investing now (and rates are low), you might want to stagger your annuity purchases over several years. This allows you to average out your interest rates.
Don’t Rush the Process
An annuity investment isn’t something you want to rush into. If someone tries to push you into purchasing one before you’re ready, this is a pretty good sign that they do not have your best interests in mind. Be patient and avoid rushing the process. As you gather the facts, you’ll get clear on which option is best for you and your future.