You might have heard some not so favorable comments about annuities, but the fact is there is no other financial vehicle that can do what an annuity does. An annuity guarantees income according to the contract between the insurance company and the owner.
Let’s start with where annuities come from. Annuities are issued by insurance companies, so the strength of the company you choose is important. An annuity is a contract between the insurance company and the contract owner. They are designed to provide a steady income stream in retirement. There are some drawbacks to consider, so the owner should work with a financial professional to ensure they make an informed decision.
There are various types of annuities, including fixed, fixed-indexed, and variable annuities. Each has varying levels of risk, so it’s important to understand what those risks are.
Benefits of Annuities:
- A major benefit is you choose whether to draw a guaranteed income for lifetime or for a period certain. This means a guaranteed income stream for the rest of your life or for a certain period of time. This can give a sense of security and independence to those concerned about outliving their retirement savings. Annuities can offer tax-deferred growth, meaning that any earnings on the investments within the annuity are not taxed until withdrawn.
- Another advantage of annuities is their potential for creditor protection. In some cases, annuities are shielded from creditors, which can be a crucial consideration for individuals in certain professions or with significant liabilities.
- Your money goes to work for you right away. Generally, there are no fees or load costs associated with starting an annuity (unless variable annuity with a management fee). Since the insurance company absorbs the costs of paying commissions and costs for getting the contract started, please note the sections below that talk about lack of liquidity and surrender charges.
- Annuity Riders
- Inflation or Cost of Living rider- While the income stream provided by an annuity may seem attractive at first, the purchasing power of that income can erode over time if it does not increase with inflation. With this rider, the annuity payments adjust annually to keep up with inflation.
- Long-term care (LTC) rider – A LTC can help cover LTC expenses such as LTC care, nursing home care, or home health care. Depending on the insurance company this would mean if you could not do 2 out of the 6 actives of daily living (ADLs) that the insurance company would increase the annuity amount to help with the additional expenses.
- Death benefit rider – This rider provides a guaranteed death benefit to the beneficiary, regardless of the amount left in the contract. Unlike annuities that our grandparents had, if the owner of the annuity passes away, the remaining amount left in the annuity would be paid to the beneficiary(ies).
Drawbacks of annuities
One of the undeniable drawbacks of an annuity is the lack of liquidity. Once the money is placed into an annuity, there is generally a schedule outlining a surrender period. In many cases, the owner has access to a percentage of the funds each year without penalty, but a penalty would be owed if the amount withdrawn exceeds the free surrender amount.
A surrender charge may be applied if you withdraw or surrender the annuity policy before the surrender period. Surrender periods vary based on the length of the policy. But generally, the surrender charge decreases each year until there is a 0% charge by the end of the annuity period.
In conclusion, annuities can be a suitable retirement strategy for investors seeking a guaranteed steady income stream. It is essential to work with a financial professional to weigh the pros and cons before investing in an annuity. Understanding annuity benefits, drawbacks and surrender charges is crucial for making an informed decision that aligns with your retirement income needs.
