Annuities 101 - Adviser Investments

Annuities 101

September 10, 2021

Some concepts in the financial planning world are intuitive. Annuities, which often combine investment options with various forms of insurance, are not. As a retirement income tool, they’ve received increasing attention of late, especially after a provision in the SECURE Act—signed into law at the end of 2019—provided employers with incentives to include annuities in 401(k) plans.

But annuity contracts are often confusing and may not be the best solution for many retirees (similar to reverse mortgages, which we’ve covered before).

Let’s begin with the basics: At its core, an annuity is an agreement you make with an insurance company. You purchase the annuity contract either with a lump sum or via a series of payments. In return, the insurer commits to making a series of payments to you for as long as you live.

Two major factors distinguish one annuity from another: The timing and type of payments.

     When you begin receiving payments…

  • Immediate annuity: Payments on an immediate annuity (also known as an “income annuity”) must begin within one year of purchasing the contract. Immediate annuities are always purchased with a single lump-sum payment.
  • Deferred annuity: Payments begin on a future date you select. While you wait, your money in the annuity grows.

     The form those payments take…

  • Fixed annuities: Predictable and steady, fixed annuities offer a guaranteed interest rate and a fixed payment amount. The trade-off is that you might not benefit from any market growth.
  • Variable annuities: You select among investment options, often mutual funds, for preservation, growth or a combination of the two. Your payout is determined by how your investments perform.

An infographic highlighting the differences between the four types of annuities: Immediate Annuities, Deferred Annuities, Fixed Annuities and Variable Innuities

One big disadvantage is that annuities can be costly, and you may incur substantial fees and penalties if your circumstances change and you need to withdraw your money. Withdrawals made from your annuity before you reach age 59½ trigger a 10% penalty, and you’ll owe income tax on any earnings. Most contracts also include a “surrender charge” of anywhere from 7% to 20% on withdrawals made within the first five to seven years of purchase.

At Adviser Investments, we are selective when it comes to annuities. An annuity may make sense if you’re concerned that you’ll outlive your assets. And we’ve found that they are a good fit for some of our clients. But generally, we believe that with consistent savings and well-built investment and financial plans, you can grow an asset base that will sustain you in retirement without taking on the high costs of annuities.

If you have any questions about whether an annuity is right for you or about the ins and outs of an existing annuity contract that you own, please contact your wealth management team and we’d be happy to discuss them with you.

This material is distributed for informational purposes only. The investment ideas and opinions contained herein should not be viewed as recommendations or personal investment advice or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.

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