So you’re ready to retire. After maxing out your already existent tax-advantage vehicles (like your 401k and/or IRA accounts) investing in annuities might be a logical next step for setting even more money aside for retirement. But how can you make sure to find the best annuity rates available, or if an annuity is right for you at all?
Navigating the intricate world of annuities can be a challenge, which may be the reason they aren’t so popular among retirees. Stats from 2018 indicate less than 15 percent of retirees buy annuities. This article will tackle some of the pros and cons of taking the annuity route, break down the difference between deferred and immediate annuities, and define fixed, variable, and other types of annuities.
What Is An Annuity?
An annuity is a fixed sum of money paid to someone each year, typically for the rest of their life, or a form of insurance or investment entitling the investor to a series of annual sums. Once you make an investment in an annuity, it makes a payment or payment to you on a future date or series of future dates. These payments can be distributed monthly, quarterly, annually, or in one lump sum.
The payments can vary in size based on factors such as the length of your set payment period. You can determine the number of years you will receive payments, or choose to receive them for the rest of your life.
Fixed vs. Variable Annuities – A fixed annuity is when a person selects a guaranteed, “fixed” payout number, while variable annuities rely on the performance of your included investments to determine the payout.
Due to high expenses in annuities, it’s important to understand if buying one is a good investment for you to plan retirement.
2 Basics Types of Annuities
The two basic types of annuities are deferred and immediate annuities. A deferred annuity involves investing your money for a period of time before opting to make withdrawals, like planning for retirement in the future.
As its name suggests, an immediate annuity allows you to receive money soon after your initial investment, like if you’re about to retire this year. A deferred annuity can snowball money over time, while an immediate annuity pays you a fixed amount quickly. If an owner opts to begin withdrawing payments from their deferred annuities, they can be converted to immediate annuities.
Breaking Down Advantages Vs. Disadvantages of Annuities
There are mixed opinions on whether annuities are good investments or not. Below is a breakdown of some of the biggest advantages and disadvantages of choosing to invest in annuities, according to CNN.
- They allow you to stow away large amounts of money for later
- They allow you to defer paying taxes
- There is no annual contribution limit for an annuity, allowing you to put away more money for retirement
- The money you invest compounds each year tax-free
- Flexibility in cashing out: you can take a lump sum of money, or devy up guaranteed payments for a period of time or the rest of your life to earn steady a steady income after your working life is over
- Buyer beware: hidden fees can lurk in annuities, cutting into annual profits the annuity pays out
- Commissions: insurance brokers that sell annuities often take up to 10 percent in commission rates
- Surrender charges: a surrender fee (often around 7 percent but can be as high as 20 percent) is often in place for those pulling money out of annuities within the first few-to-several years of purchase. Generally, the percentage declines by 1 percent annually until it reaches 0.
- High annual fees: variable annuities bring high annual expenses, such as annual insurance charges, investment management fees, and others, which can bleed your retirement fund and often cancel out annuity benefits if high enough
- Early withdrawal penalties: it’s recommended that those with annuities wait until age 59-60 to avoid early withdrawal penalties of up to 10 percent
Is An Annuity For Me?
First, you must be willing to put away money for years. Making a withdrawal early after an annuity can be costly, with other fees garnished throughout the process. Be sure you fully understand the plan you’re signing up for, as sellers can often downplay the risks or cons of annuities while singing their praises.
When accessing the fee structure of your annuity investment plan, it’s recommended to compare those fees to regular, no-load mutual funds, which demand no surrender charge, or commission rate, and generally impose less annual expenses on average, and make an educated decision about your best course of action.
Earnings you withdraw from annuities will be taxed as regular income. According to CNN, the maximum income tax rate is 39.6 percent but can increase if your retirement is still a few years away.
FAQs About Annuities – A Recap
What if I no longer want the annuity I purchased?
You can request to surrender the annuity, though it may cost you.
If you’ve only owned the annuity for a few years, a surrender charge of up to 7 percent could apply to withdrawals made in the first year, with a percentage point decrease every year after. You’ll need to pay income tax on your investment earnings, and if you are younger than 59.5 years, you’ll likely be hit with a 10 percent early withdrawal penalty.
What happens to my annuity if I die?
It depends. You can name a beneficiary on your annuity, and they can receive the money in your annuity if structured properly. Based on the type of annuity and your payout methods, procedures can vary on how your annuity is handled after death.
Some plans opt to simply cease payments after death.
Can I exchange my current annuity for another?
Yes, but be wary. Make sure you understand the consequences and potential fees of exchanging. Annuity exchanges are called 1035 swaps. A salesperson could pitch a 1035b swap as an enticing option by highlighting the new annuity features without being subject to taxes. But they’ll often set a hefty commission rate for such services. Also, beginning a new annuity also begins a new surrender charge timeline. So if you’re in the seventh year of your first annuity, and switch to a new one, the rate for early withdrawal will reset to typically 7 percent for the next several years.
Annuities can be a useful tool in retirement planning, but make sure you understand the ins and out’s of the business, have reliable consolation and understand the consequences of withdrawing the annuity income.
Choose the right annuity plan for you, only after exhausting and becoming aware of all other tax-advantaged options. The pros and cons of annuities may vary greatly between individuals.