An annuity: What you should know before you purchase it

An annuity was designed to convert a lump sum of money into a steady stream of income for a certain period or for life. It was suitable for those who were planning to retire or needed a guaranteed and fixed monthly income. Today, you can find different types of annuities that you can use to accumulate funds through investment besides a guaranteed income. Therefore, an annuity income refers to an annuity contract that can pay income once the policy is initiated. 

When funded, an income annuity can be annuitized right away, but the underlying income units can be in either variable or fixed investments. Hence, the income payments tend to fluctuate over time. You can use an annuity calculator to determine how much you need to invest so that you can receive a stream of income in the future. This page discusses an annuity.

The type of annuity

The first thing you have to remember is that there are various types of annuities. In most cases, annuities are contracts offered by insurance companies. Some of them you can use to save for retirement while you can use others to assist to guard against the chances of outliving your assets. The major categories of annuities include fixed, indexed, and variable annuities. 

A fixed immediate annuity

With a fixed immediate annuity, you usually pay a lump sum as a premium payment or purchase payment to an insurer and you can get a monthly payment in exchange. Take note that the premium payment cannot be reversed when you turn it over, meaning you cannot access it again to your premium. The good thing is that the insurance company can guarantee you monthly payments for a specific period you choose for the rest of your life or even for the rest of your spouse’s life. This annuity is quite straightforward and has specific fees or costs, and can work well alongside your portfolio of investments. 

You can decide to choose a single premium immediate annuity which starts paying you a steady stream of income each month right after you purchase it. The payments can continue for life regardless of market performance or future interest rates. 

There is also a deferred annuity that allows you to choose any time in the future when you desire the payments to begin. Other than this, this annuity works just like an immediate annuity. Quite often, it’s a good idea to buy this annuity when you are 65 years old and begin earning income when you are 85 years old.

Deferred annuity

You can find some tax-deferred retirement savings tools that include investments in your insurance contract so that you can have the chance to participate in market growth. One type of deferred annuity is called a fixed indexed annuity that tracks an index, and your profit tends to be capped at a specific level.

The only problem with this annuity is that you may underperform conservative investments, especially during poor market performance years. The good news is that you can outperform conservative investments in good markets. 

Another type of deferred annuity is known as variable annuity. This annuity allows you to invest in an underlying sub-account. There are chances that you can lose some money due to market exposure. 

A fixed indexed annuity and a variable annuity are often more complex than a deferred and fixed immediate income annuity. This is because they usually provide a wide range of riders or optional features for a fee, such as guaranteed lifetime withdrawals and death benefits. They can sometimes have more complex terms, income floors, guaranteed payout amounts, and many more. 

Unlike a fixed immediate and deferred income annuity, a fixed indexed annuity and a variable annuity that have optional living benefits don’t need you to turn over an irreversible lump sum. Because of this flexibility, the annuity provider can put surrender charges, meaning that there can be early withdrawal fees or they can lower income benefits, especially if you decide to withdraw more than a specific amount every year.

A fixed indexed annuity and a variable annuity can allow you to convert the assets into periodic payments for a specific period or for life. The good thing is that there is no cost that applies with this option, but you tend to give up control of the assets. Most fixed indexed annuities as well as variable annuities provide an optional living benefit rider. This rider gives you the chance to withdraw cash each year, but after a specific period determined by the rider. 

Quite often, depending on the annuity contract, the rider can state that you may have a guaranteed withdrawal amount of money each year for the rest of your life. But you need to understand and remember to find out the costs and details from your annuity provider. Just like any other income annuity, the guarantee associated with a fixed indexed annuity and a variable annuity can be subject to the claims-paying ability and strength of the issuing insurance company.  

How an annuity works with your other income

Before you decide to purchase an annuity, you need to consider your retirement income, investments, assets, and savings. In this way, you can determine the purpose of each income stream.

If you are worried of outliving your savings and desire a high level of guaranteed income that is not influenced by financial markets, then you have to allocate part of your retirement savings to fixed-income annuities and invest the rest of your portfolio of investments. A combination of portfolio and annuity payouts can be helpful, especially if you get Social Security benefits or a pension that doesn’t fulfill your financial needs. 

Alternatively, you can buy a deferred income annuity that starts to pay out later in your life. But this can require a smaller investment and helps to mitigate against the risks of you outliving the portfolio. You can diversify the rest of your savings so that you can have additional income and growth potential. 

A fixed indexed annuity and a variable annuity that has optional living benefits may also work with your current portfolio and sources of retirement income. But these tend to be more complex and may require further scrutiny.


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