What Are Annuities and Should You Consider One?
Should annuities be part of your retirement plan? Some would say no, but once you know what they are and how they work, they could be a good option for you.
In this post, we’ll show you what annuities are and the different types available, before looking at ways to make them work for you.
What is an annuity?
An annuity is a retirement product that offers a steady income stream in retirement. They’re designed to provide a source of income for the rest of your life and are typically set up so that you can’t outlive the payments.
You can contribute to an annuity alongside other retirement contributions, like a pension, IRA, or 401k. Think of them like a certificate of deposit (CD) or a bond, whereby you invest a lump sum with the understanding that you’ll be remunerated at a later date.
How do annuities work?
Annuities are a long-term contract between yourself and an insurance company, which guarantees income-for-life payments when you retire. It’s when you give a lump sum of money to an insurance company, which converts it to an income stream that you can’t outlive – providing a lifetime of income.
Here’s how they work:
- You pay a lump sum to an insurance company – let’s say $100,000 as an example.
- You choose the type of annuity plan you want – there are two major types available, immediate and deferred. Keep reading for more information on the pros and cons of these different options.
- You start receiving income-for-life payments – this is either when you reach retirement age or at a time agreed with the insurance company.
Annuities can be complicated and are often misunderstood. But so long as you remember the basics of how they work, they can be a valuable addition to your retirement plan.
Why should you consider an annuity?
There are three key reasons why people look at annuities as part of their retirement plan.
The first concerns guaranteed income. Annuities offer the peace of mind that you’ll receive a reliable income when you retire, and these are payments that will continue for the rest of your life.
The second reason to look at annuities is that they’re considered a safe and profitable place to keep your money. If you choose a deferred annuity plan with a fixed interest rate, you’ll receive a guaranteed rate of return – helping to top up your savings for when you retire.
Lastly, annuities often bring a death benefit, meaning guaranteed money for your loved ones when you’ve gone. Though not one of the main reasons to invest in an annuity, it is a benefit that you may appreciate when thinking about your inheritance.
The pros and cons of different types of annuities
If you decide an annuity is right for you, the next question is: which type should you go for? As we touched on earlier, there are two main types of annuities to choose from, immediate and deferred. Let’s take a look at how they work and the pros and cons they offer.
An immediate annuity is a retirement product that you can access within 12 months of investing. It’s when you give a lump sum to an insurance company, which then distributes it back to you based on a defined schedule or over your lifetime.
The main benefit of taking out an immediate annuity plan is the guaranteed income it provides. It means you don’t have to worry about budgeting your savings, instead you’ll receive regular payments that you can live on through retirement.
One of the downsides of immediate annuities is that they aren’t flexible. As soon as you make a lump-sum payment to an insurance company, you can no longer access it. This could mean you find it difficult to make large, one-off purchases in retirement, especially if you don’t have other assets to rely on.
A deferred annuity isn’t as straightforward. Often compared to a CD or a bond, this type of annuity is a long-term investment where you can store money until you retire.
To further complicate things, there two types of deferred annuities, fixed-rate and variable. A fixed-rate annuity guarantees a reliable rate of return on your investment, while a variable annuity means your investment is subject to the highs and lows of the financial market – meaning you could lose money.
In most circumstances, we’d always advise a fixed-rate plan when considering a deferred annuity. It’s much safer if you’re relying on that money for later life. You’ll also get the benefit of added interest without the worry that you could lose money.
It’s worth noting that with a deferred annuity, you can withdraw money up until the point that you start receiving regular payments. Say, for example, you want the payment plan to begin when you’re 75. You could pay into a fixed-rate annuity before you retire, while still having access to your investment up until the regular payment schedule begins.
How to plan for an annuity as part of your retirement
Arranging an annuity for your retirement might sound complicated, but it doesn’t have to be. Provided you know what your assets are and how much money you’ll need in retirement, an annuity can be a feasible part of your retirement plan.
Whether you opt for an immediate or a deferred annuity, you’ll need a lump sum to give to the insurance company. This money usually comes from income sources like savings, pensions, social security, or the equity released when selling your property.
When deciding how much to invest in an annuity, be realistic about what you’ll need in regular income when you retire. Think about essential costs – to cover things like food, bills, and accommodation – as well as disposable income that will give you the freedom you deserve in retirement.
Financially planning for an annuity can feel overwhelming, but help is available. Our experts will consider your income and show you the options available, creating a customized retirement plan that meets your requirements and goals for retirement.
We hope we’ve cleared up some of the misconceptions you may have had about annuities. If you need help setting up an annuity for your retirement, don’t hesitate to get in touch. Book a complimentary 15-minute call with a member of our team to discuss your retirement goals today.