For some people, traditional retirement accounts may not provide enough income once they decide to stop working. People in this position may want to consider an annuity, which is a product that offers a steady stream of income for the life of the policyholder.
However, there are many different types of annuities, and deciding which one is the best for you can be quite difficult. Some types of annuities come with attractive add-ons, while others offer variable interest rates. In the end, you should decide which type of annuity makes the most sense for your circumstances and then shop around. Never sign up for the first annuity you find—they can vary quite a bit, even within the same general category.
Deciding between Immediate and Deferred Annuities
When looking at annuities, you will have to choose between immediate and deferred payments. With an immediate annuity, you collect payments right away, which can sound quite appealing. A deferred annuity means that you begin collecting money down the line after depositing money.
With a deferred annuity, you choose the specific date at which you begin to receive payments. Importantly, the sum that you pay will typically accrue interest or see market gains during the interim depending on the specifics of the product. You will need to plan for a deferred annuity since you need to purchase it before you plan to start receiving regular payments. At the same time, this option often makes the most sense for retirees.
An immediate annuity comes with a quick payoff, but not without a sacrifice. This involves the interest rate you get on the money you pay into the annuity. Immediate annuities have relatively low rates, so returns are quite limited. Also, many immediate annuities do not come with inflation protection, which is not the case with deferred options. Thus, the income you receive from the annuity will not stretch as far down the line. This is especially problematic since that is when you run the risk of emptying your retirement accounts and will need extra income more than ever.
Choosing between Variable and Fixed Annuities
The other major decision when purchasing an annuity has to do with the returns you receive. A variable annuity provides a return based on the performance of underlying investments, which are typically mutual funds that are tied to market indexes. Variable annuities also come with options called riders that can guarantee a certain amount of return for your life, create a death benefit for heirs, or secure other appealing guarantees.
On the other hand, fixed annuities come with a guaranteed return when payments start. The rate of return is fixed for a certain number of years or for your lifetime, depending on the specific product. The fixed rate can be fairly low, but it provides some peace of mind.
Many retirees are attracted to variable annuities because of the riders and the chance of larger returns, but this is not always the best decision. Riders often cost a lot of money for a benefit you may never end up using, plus the fees are not refundable. Furthermore, variable annuities tend to be very complex and expensive investments. The number of fees associated with them can be overwhelming and cut into returns to the point that they are as low as fixed annuities, if not lower. Costs often range as high as 4 percent per year. In addition, you will incur fees if you decide to cash out your annuity early with the variable options.
Identifying the Best Option for Your Retirement
For many retirees, the best option may be one often overlooked: the basic fixed-index annuity ( FIA)without riders or any other options. With this annuity, you have the potential for added gains from the performance of a market index. Sometimes the upside potential is capped, but there are most often options for participation in indexes that are not capped, and these are the best to pursue most of the time. FIAs often have no annual fees or perhaps 1%/year, and they offer guaranteed principal, and guaranteed death benefits, and lock in all your earnings every year, and can give you increasing income for as long as you ( and a spouse) may live!
Another great benefit of fixed-index annuities is the ability to withdraw up to 10 percent of the value of the contract for emergency expenses without any penalty. Not all annuities offer this, however, so make sure you find one that does. The benefit comes without any added cost and provides great flexibility to retirees. Furthermore, companies will often guarantee a minimum income rate for fixed-index annuities and sometimes provide boosted rates for the first year of the contract.
Of course, fixed-index annuities also have their downsides. Liquidity is limited with this product unless you are willing to pay early withdrawal fees. Also, the language in the contracts can be confusing, so you may need professional help deciphering it. Financial advisors who have experience with these products can guide you in finding one that is right for you.