Is Using Annuities for Retirement Income Good or Bad?
The most important financial goal one can have is to save for a comfortable retirement. Very few Americans have the luxury of retiring with a hefty pension and therefore planning ahead of time is imperative. The only guaranteed retirement income many rely on is Social Security and that may not be enough to pay for your retirement and living expenses. Taking a look at other options to help diversify your income is important and can help give you a better lifestyle.
We will be taking a look at annuities and answering the questions many of you have. Are annuities good or bad? Are annuities a good investment? What are the pros and cons of annuities?
First, let’s identify what annuities are. Annuities are an investment or form of insurance that entitles the investor to a series of annual sums of money. There are numerous types of annuity funds such as fixed, variable, immediate and hybrid annuities which all differ in risks, payouts and benefits. Speaking to a certified financial advisor can help you understand the details on each type. For this article, we will focus on fixed annuities. Fixed annuities have a minimum rate of return that never changes regardless of what happens in the financial markets. You are always guaranteed a stable amount of cash for a set number of years or for life while the insurance company carries the majority of the risk.
You can also add additional benefits known as annuity riders. These act as extra protection for your financial investment at an extra cost. Examples of annuity riders include income riders, nursing home riders and death benefit riders. An income rider guarantees you income for a certain amount of time in which you are able to choose the start date that you will begin to receive your distributions. A nursing home rider helps cover expensive long-term care. A death benefit rider ensures that a family member or beneficiary will be able to collect the remaining principal payment that you invested should you die before receiving the full amount.
So what types of pros and cons do annuities carry?
Well, I am glad you asked! Let’s review a few to help you understand annuities a bit better. By weighing out the benefits and risks associated with annuities you can make a confident decision whether to invest in them or not.
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Pro #1: Guaranteed Income for a Set Number of Years or even for Life!
Annuities allow you the option to opt for income for life. For example, if you purchased a $100,000 lifetime fixed annuity with a 8% income rider at age 55 and waited until age 65 to begin receiving distributions, you’d receive a guaranteed $1,000 per month for the remainder of your life. This is preferable to some people who don’t have the time or skill to manage a stock portfolio and do not want to deal with the ups and downs of the market. Peace of mind is a great addition to have during a quality retirement.
Pro #2: Principal Protection
One of the most notable features of fixed annuities is that the value of the annuity will be guaranteed to be at or above the initial amount that you invested. It is guaranteed that you or your beneficiaries will receive back at least what you invested in the annuity. An example of this was seen when discussing the death benefit rider.
Pro #3: Tax Benefits
Any financial growth that occurs with your annuity is tax deferred. What this means is that as your money compounds throughout time, you do not have to pay taxes until you begin to take withdrawals. When you opt for a fixed annuity with an income rider, your payments are part principal and part growth earnings. The principal was put in post-tax so that portion is non-taxable. The only portion that you will owe tax on is the earnings portion of your withdrawals.
Pro #4: Inflation Protection
Annuities give you the ability to customize your investment to your needs. You can customize an annuity to ensure that your annual stream of income keeps pace with inflation. This is critical because inflation can cause an upsetting effect on your assets. The only downside to adding this feature is that it will cost more and can cause your first payments to be lower.
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Con #1: High Costs
Many annuities come attached with a high sales commission or a hefty annual fee. For this reason, it is important to shop around and really study the details of any investment contract prior to purchasing.
Con #2: Lack of Flexibility
Annuities tend to be one of the least flexible investments that are available to retirees. For example, once you purchase an annuity contract your money is tied up and unless you pay a very high fee to retire the money, you do not have access to the lump sum. In the instance of a large unplanned expense, an annuity may not be seen as the best investment choice. For this reason, studying, working with your financial advisor and learning about annuity riders can help with these unforeseen expenses.
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So, are annuities a safe investment? Annuities are a great investment tool that can be customized to your needs and wants during retirement. Doing your homework and speaking with an annuity advisor to review all of the pros and cons can help you with your decision before diving in.
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