Annuities 101 - Adviser Investments

Annuities 101

August 7, 2020

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, hard to navigate and may not be the best solution for many retirees (similar to reverse mortgages, which we covered last week).

At its core, an annuity is an agreement you make with an insurance company. You purchase the contract with either a lump sum or as 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: When you begin receiving payments and the form those payments take.

  • Immediate annuity: Also known as an “income annuity,” payments on an immediate 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.
  • Fixed annuities: Predictable and steady, fixed annuities offer a guaranteed interest rate and a fixed payment amount. The tradeoff 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.

One big disadvantage: Annuities can be costly and there are some liquidity issues to contend with. Any withdrawals made from your annuity before you reach age 59½ incur 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 because of their complexity and high costs. An annuity may make sense if you’re concerned that you might outlive your assets. And we have 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 annuities’ high costs.

If you have any questions about whether an annuity is right for you or the ins and outs of an existing annuity contract that you own, please contact your wealth management team. We’re here for 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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