Annuities: Basic Definition
An annuity is an insurance product that pays out income and can be used as part of a retirement strategy. Annuities are a popular choice for investors who want to receive a steady income stream in retirement. They can be used to help you increase your retirement savings, protect what you’ve saved or generate a stream of income. Specifically, an annuity is a contract between you (the annuity owner) and an insurance company. In return for your payment, the insurance company agrees to provide either a regular stream of income or a lump sum payment at some future time (generally, once you retire or pass age 59 1/2).
You can opt to receive payments for the rest of your life, or for a set number of years. How much you receive depends on whether you opt for a guaranteed payout (fixed annuity) or a payout stream determined by the performance of your annuity’s underlying investments (variable annuity).
Types of Annuities: Variable and Fixed
Variable annuities contain investment options that allow the investor to take advantage of potential growth opportunities. However, this approach involves some market risk and could lead to losses if the value of the underlying investments falls. Variable annuities are usually appropriate for individuals who have longer investment time horizons, tend to have a higher tolerance for potential market risk and are therefore better able to handle fluctuations in the market. Principal value, income payments, and investment returns of a variable annuity will fluctuate and you may have a gain or loss when money is received or withdrawn.
Fixed annuities offer a guaranteed, predictable payment for life, or for a specified period of time. The guaranteed income payment cannot be affected by market volatility, which helps to shield your retirement income from market risk. Fixed annuities may be more appropriate for conservative investors or for those who are closer to retirement and want to protect their assets from market volatility.
Fixed Annuities: The Basic Pros and Cons
One of the most appealing aspects of a fixed annuity is that it pays a fixed dollar amount for the duration of the investment. Another appealing feature is the ability to provide income for the duration of an individual’s life. A lifetime annuity gives retirees a fixed income that they will not outlive. The fixed annuity can be a very useful financial planning tool, particularly in retirement planning. Individuals looking for a steady and guaranteed income will find the fixed annuity to be appealing.
While the fixed annuity can provide a definite and recurring stream of income, it can also come with penalties if you change your mind. Most annuity contracts have surrender charges if you attempt to get your money out faster than the predetermined rate.
Consult Your Advisor
Fixed annuities can be a very useful financial planning tool, particularly for retirement planning. Individuals looking for a steady, guaranteed income stream will find fixed annuities to be particularly effective. Like any investment, it is important that you understand the facts before purchasing an annuity. Fixed annuities are not for everyone. Each individual’s situation is unique and therefore seeking guidance from an advisor is suggested to determine if an annuity makes sense for you.