Annuity - SafeMoney.com

fixed annuity vs cd

If you are looking for a decent rate for your money, your local bank might not offer much to write home about. We already are in a low-interest rate environment, and the Fed doesn't appear to be ready to raise rates anytime soon.

This is, of course, one of the effects of recent public health and economic conditions, which also might not be winding down anytime soon.

When it comes to earning interest, one option that banks offer is a certificate of deposit.

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how much income will an annuity provide

How much income will your annuity contract pay you? The answer depends on what age you start collecting income from your annuity.

If you start income at age 70-75, you will receive higher payouts. If you begin your annuity income in your mid-50s, it will be less than what you would receive in your 60s or later.

Annuities therefore resemble Social Security in that their payouts will increase the longer you wait to take them. But annuities with qualified money, or pre-tax dollars, in them have required minimum distributions that must be taken by age 72.

Why is this? Since the insurance company is on the hook for paying you guaranteed income for a certain period or life, it manages its risk based on the age of when you start that guaranteed income stream.

The insurance company also builds estimates of statistically how long it believes you will live into every single one of its income payments. These estimates are based on life expectancy and mortality data.

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what are the risks of annuities

Annuities can help strengthen your overall retirement strategy with their unique guarantees.

From lifetime income to growth or protection, their contractual guarantees can help in many areas. But just like with any other instrument, annuities also have risks of their own.

What are these risks of annuities? What should you keep in mind as you consider an annuity contract for your retirement?

Here's a quick rundown of different risks of annuities and some other information that can help with your decision-making.

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annuitization should i annuitize my annuity

Annuities are becoming an increasingly popular retirement savings vehicle for people in the U.S. Many folks are seeking alternative instruments that can guarantee them a stream of income for life.

With corporate pensions gradually disappearing from the financial marketplace, annuities have emerged as a viable substitute for these bygone streams of income.

Most annuity contracts today come with a variety of benefits and features that were unheard of a generation ago. Living and death benefit riders, guaranteed income riders, and disability and long-term care riders are now commonly available in many annuity products.

However, in order to take advantage of many of these benefits, the annuitant will have to give the insurance company permission to annuitize their contract.

Annuitization is a one-time, irreversible event that ends the accumulation phase of the annuity, where money was being put into the contract or a lump sum of money was left to grow on its own. Annuitization marks the start of the payout phase of the annuity.

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what should i do with my annuity at maturity

From variable to fixed annuities, millions of people buy annuity contracts for many reasons. These purposes range from lifetime income to asset protection and tax-advantaged growth. As a contract, each annuity has a different time period that it takes to mature.

Depending on what you buy, your annuity may have a maturity period that goes only for a few years. If your annuity has more benefits or the benefits are guaranteed for a longer time, its maturity period can be as long as 15 years.

But what about when you are on the backend? What should you do with your annuity at maturity? Annuity owners have a variety of options when they reach that point.

Depending on your age, financial situation, and the goals that you have for your annuity money, you can do the following when the contract ends:

  • Keep your money in the contract and withdraw it at strategic times (or a certain withdrawal schedule),
  • Cash it out in a lump-sum balance,
  • Renew your contract,
  • Annuitize your contract into an irreversible income stream, or
  • Transfer the money into a new annuity contract.

Let's go into more details about what you can do when your annuity contract matures.

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how does an index annuity differ from a fixed annuity

There are many different types of annuities available in the financial marketplace today. Two of the more popular types of annuities are fixed annuities and indexed annuities. Indexed annuities are also known as fixed index annuities nowadays.

Both kinds of annuities can have their place in a retirement financial plan. But there are key differences between a fixed and an indexed annuity that people should understand in order to make an informed decision when choosing which type to use.

Before we delve into the differences between fixed and indexed annuities, it’s good to know the ways in which they are similar.

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multi year guarantee annuities explained

For retirement savers wanting more growth potential than what CDs and other fixed-interest assets might offer, fixed index annuities can be an attractive option. Indexed annuities can earn more interest over time than what these other options might.

Even so, some people would rather know that they are earning a guaranteed rate of interest. They are more comfortable with a minimum interest rate for their money’s growth.

Multi-year guaranteed annuities, or MYGA annuities, can fill this role for those who want a guaranteed interest rate with full protection of principal.

Multi-guarantee annuities are backed by the same dollar-for-dollar reserve requirements that apply to fixed and indexed annuities.

That means that for every dollar of MYGA premium that is issued, the insurance company must keep at least one dollar in its cash reserves to cover the outstanding amount.

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annuity with an income rider

The modern financial landscape for today's retirees is quite different from that of prior generations. Corporate pensions are disappearing, and the Social Security program faces new pressures from record-breaking numbers of people retiring.

Annuities have steadily emerged as a solution to these retirement income challenges. But up until some years ago, many retirees eschewed the use of annuities. Why? Because in order to get a guaranteed lifetime stream of income, they had to annuitize their contracts.

In order to do this, they had to effectively forfeit control of their money for the rest of their lives. Thankfully, life insurance companies have innovated and come up with a new benefit that gives more flexibility: an annuity income rider benefit.

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what types of annuity are there for you

So, you have decided that an annuity makes sense for your retirement. But what type of annuity might be right for you? This will depend on the answers to a variety of questions.

What is your risk tolerance? What timeline do you have for your money? What annuity guarantees are important to you? What you hope to accomplish with the annuity contract? All of these considerations and more are relevant to what annuity might be a good fit for you.

Here are some questions to consider as you think about what annuity might be right for your situation.

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how can guarantees help your retirement

Annuities can bring more stability and certainty to a retirement portfolio. But how do you know you are getting a good deal for your money?

The biggest advantage that annuities can give for your retirement is their guarantees. Or in other words, the contractual assurances that the contract-issuing insurance company promises to provide you.

For your retirement, you might already have a number of financial guarantees that will contribute to your retirement security.

You paid into the coffers of Social Security during your career. In exchange, Uncle Sam guarantees you will receive a monthly paycheck from the SSA once you begin your benefits.

If you buy Treasury securities, you are guaranteed a return of your initial principal once the bonds mature. The bonds also pay you guaranteed semiannual interest payments during the maturity period. You also have these same guarantees when you hold a CD from the bank.

Many Things in Retirement Aren't Guaranteed

Of course, other parts of retirement don't come with guarantees.

You aren't guaranteed for your money to grow when investing, although most likely your money will grow over the long run. Historical market data shows and suggests this.

However, you can lose money, and even your principal, during periods of market losses. This can be a bigger hit especially if you are the cusp of retirement and ready to start taking income from your portfolio.

When financial uncertainty arises, experts acknowledge that fortifying your portfolio with the guarantees and actuarial precision of annuities can benefit you in more ways than one.

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bonds vs annuities for retirement

If you asked a hundred financial advisors about what they use to construct retirement strategies, you would surely get as many opinions as there are flavors of ice cream.

Many portfolio strategies today call for strategic mixes of equities and bonds. Lots of research is on the so-called 60/40 portfolio, made up of 60% equity assets and 40% bond assets.

The problem is that bonds are particularly vulnerable to interest rate risk, which is the danger of an asset losing value when interest rates rise. And with interest rates sitting at basically zero percent for the foreseeable future, the only direction they can go is up.

This isn't to say that bonds don't have a place in a retirement income strategy. But there is also the flip-side to consider.

Do you really have all options on the table if your advisor leaves annuities out of the conversation? Unlike bonds of any sort, annuities are unique in that life insurers include estimates of people's expected mortality into their payouts.

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annuities monopoly lifetime income

Unlike other types of vehicles, annuities are the only financial instrument capable of paying a guaranteed lifetime income. They are the only one on the planet. No individual investor can duplicate what insurance companies can offer you with paying you a guaranteed income stream.

Nor can any other asset class do what annuities do. They have contractual guarantees backing them.

Dollar-for-dollar capital reserve requirements, as well as mortality estimates built into every single payout by the insurance company, makes these income promises quite dependable. In this sense, annuities have a monopoly on lifetime income.

You can choose to receive guaranteed income for a certain timespan. Say you need guaranteed income for just 10 years. Then your guaranteed income can be structured to last for that long. Or you can receive guaranteed income for the rest of your life, regardless of how the markets perform.

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what does an annuity protect the contract owner against

Many people buy annuities for protection. But what kinds of protection can they provide? The answer depends in large part on the kind of annuity you own.

At the very least, all annuities can protect you against the financial risk of running out of money in retirement. Annuities counter this hazard by paying you a guaranteed income. Your income can last for a certain timespan or for life. This protection is available with fixed-type and variable annuities alike.

However, fixed annuities also protect the contract owner against downfalls tied to market risk, long-term care costs, and financial risks that can derail your legacy wishes. Here's a rundown of what an annuity can protect you against in your retirement-saving and post-retirement years.

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retirement annuity is retirement annuities right for you

In times of wild market swings and low-interest rates from Treasurys, CDs, and other fixed-interest assets, annuities can bring a sense of calm and predictability to a portfolio. Many people refer to annuities as "retirement annuities," because they are particularly well-designed for retirement goals.

Annuities are the only instrument capable of paying you a guaranteed income stream for as long as you live. No other instrument on the planet offers this.

You can think of this in terms of a monthly paycheck or money for life. You will receive a check in the mail from the life insurance company that you can count on, again and again, for the rest of your lifetime.

That is no matter how equity markets perform. Annuity income can therefore be seen as a kind of "private pension."

Speaking in an analogy, you already have your own annuity with Social Security payments. You paid into Social Security's coffers during your career. Then, when retired, you receive a monthly income that pays you like clockwork.

Annuities work in much the same way. They can be a great supplement to the assured income you will receive from your Social Security payouts.

Depending upon your overall goals, annuities can also help you reach your objectives with other contract features as well. Here's a look at why retirement annuities can bring predictability to your lifestyle and stability to your portfolio.

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how do annuities give market protection

Sometimes the stock market can go through a rough patch. The market takes a dive, and then the near-term outlook for stocks might not be that rosy. During those times, many people go on the hunt for ways to keep their money safe.

For millions of Americans, one answer is fixed-type annuities. If you are considering annuities as a place of refuge, then this next question couldn’t be more important for you.

If you had money in a fixed annuity or a fixed index annuity and the market dropped, how much money would you lose? The answer, of course, is not even a cent due to the market falling.

One of the benefits of fixed and index annuities is their guarantee of principal protection. When you put money into a fixed index annuity, the insurance company pledges to keep your money protected from falling index values. The financial safety nets that it maintains to protect your money are indeed very strong.

Even if the market sees a swing like it did in the early 2000s or in 2008, it wouldn't matter. Your money will stay intact inside your annuity contract.

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who guarantees annuities

People buy annuities for many reasons, from market protection to guaranteed income payouts. After all, an annuity is the only instrument capable of paying a guaranteed income for life. But who guarantees annuities? What sort of safeguards stand behind those guarantees?

The annuity guarantor is, of course, the life insurance company issuing the contract.

By law, life insurance companies must maintain very strict capital reserves for every dollar of fixed annuity premium. State regulators require annuity insurers to keep dollar-for-dollar reserves in coverage for every dollar of fixed annuity premium they hold.

Many life insurance companies hold reserves above this. For example, some insurers have $1.08 in reserve capital for every annuity premium dollar.

Hence, this is what financial pundits mean when they say that a life insurer's ability to make good on their annuity promises depend on that company's financial strength and claims-paying ability.

What about other safeguards if an insurance company has a liquidity problem? There are also other measures that state insurance regulators put in place as a financial safety net.

Let's get more into the details of how insurance companies' financial strength are monitored. We will also cover some of these other safety net features that help back up fixed annuity guarantees to policyholders.

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what are the risks with annuities in a recession

Annuities have become increasingly popular in recent years. While due to many reasons, two big ones are that annuities pay guaranteed income and provide tax-advantaged growth for your money.

The biggest advantage of their guaranteed payouts? Your income stream doesn't change with political or economic conditions, such as a recession.

The technical definition of an economic recession is two successive quarters of negative economic growth. The National Bureau of Economic Research (NBER) is the body that determines when the U.S. economy is going through a recessionary period.

According to research by NBER and graph data from the Federal Reserve Bank of St. Louis, the United States has been through 17 recessions since 1920.

what are the risks with annuities in a recession img 2

Annuities come in all sorts of flavors, but the two primary flavors are fixed annuities and variable annuities. One type of fixed annuity, the fixed index annuity, is so popular with retirees and working-age retirement savers, it’s also worth a mention.

The biggest risk with annuities in a recession is risk of loss – or how much the money you have parked in the annuity loses value due to market conditions. Depending on the type of annuity you hold, your money might be at greater risk for loss based on how the market behaves.

Let’s go into more depth about these annuity types and how a recession affects them differently.

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annuity prices what you need to know

How is an annuity priced? And why should it matter to you? While you may be exploring an annuity for your retirement, many Americans count on fixed annuity contracts as a safeguard against today’s economic uncertainty.

In many ways, retirees and retirement savers have had a rough go in this ever-changing economic climate. Retired Americans have sought to find choices that pay sufficient regular income for their monthly household needs. Risk-averse savers also have been hit particularly hard, as interest rates still remain near historic lows.

Millions of people have found peace of mind by receiving a lifetime income stream from an annuity contract. This type of payout will guarantee someone a fixed sum of money on a regular basis for as long as he or she lives.

But how can you, the annuitant on the contract, know if you are getting a good deal on the annuity (a fair annuity price) when you buy one for your portfolio? There are several factors that enter into how a life insurance company will price its annuity payouts.

To help you receive the best “bang for your buck,” it’s good to understand how these factors can affect the pricing of annuities by insurance companies -- and the impact on the annuity payout you will receive.

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is an annuity a liquid asset

Annuities can provide retirement savers with many unique benefits: tax-deferred growth, guaranteed lifetime income, guaranteed interest rates, and protection from downside risk, to name a few.

For the most part, the IRS doesn’t have limits on how much money can be placed inside an annuity, giving people more opportunity to take advantage of the contractual guarantees. And if you want more growth potential for your money, fixed annuities and fixed index annuities can earn higher interest while protecting your principal.

However, one limitation that annuities have is their liquidity. Annuity owners give up having complete liquidity in exchange for these benefits, and if their money is in fixed-type annuity contracts, that is a very safe place with the dollar-for-dollar reserves that insurance companies must maintain.

So, are annuities a liquid asset? Yes, they offer some liquidity, but not as much liquidity as you might find in other types of assets in today’s markets. It’s a trade-off for those rock-solid, guaranteed benefits that they provide.

Even so, there are some provisions for liquidity in annuity contracts. You might access your money in a variety of ways: free withdrawals, cumulative free withdrawals, and waivers of surrender charges (where you get your money back in a qualifying situation) are a few.

Let’s talk about the liquidity of annuities in more detail.

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what is an annuity free withdrawal

One of the chief criticisms of annuities is their relative lack of liquidity. This is true in some respects. Annuity owners give up complete liquidity in exchange for other benefits, including insurer guarantees for lifetime income, guaranteed growth, or protection from downside risk.

Many annuities now come with guaranteed income riders that can be turned off and on while letting you still access at least some principal. And most contracts do offer something called "free withdrawals."

What is a Free Withdrawal?

A free withdrawal is a payment you can take out of your annuity without having to pay a penalty, or a surrender charge, as the insurance company calls it. In most cases this free withdrawal amount will be equal to a given percentage of your annuity's accumulation value each year, such as 5% or 10%.

If you withdraw more than this amount in a given year, then you will have to pay a back-end surrender charge on the excess amount.

So, say your contract allows you to withdraw 5% per year and you withdraw 7%. Then you will have to pay a surrender charge on the excess 2%.

Of course, you will generally have to pay taxes on the amount you withdraw. Since annuities are intended as retirement savings vehicles, you might also face a 10% early withdrawal penalty on any money you take out before age 59.5.  

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annuities tax efficient retirement strategies

As an annuity owner, you take comfort in knowing that you have planned for an uninterrupted lifelong retirement income stream. Working alongside other income sources from your nest egg, it will pay out, like clockwork, to fund the retirement you have always imagined.

But have you considered whether your income streams are as "efficient" as possible? Whatever retirement strategy you choose — income and all — needs to be "tax-efficient" to ensure you get the most mileage out of your money.

This is just one more piece in the retirement planning puzzle that each of us must solve. When we don't plan for retirement, we run the risk of underspending or overspending our retirement dollars.

What if underspending doesn’t seem like a problem, but rather like an advantage? Consider what events and opportunities to which you may say “no.” And simply because underspending pressures you to have a scarcity mentality, or when you don’t really know if you can afford them.

Perhaps you might pass on an important family event or skip that overseas vacation you always expected to be a highlight of your retirement years. All because you didn’t have a true picture of your anticipated income compared to your expenses.

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annuity myths image

Before you add an annuity to your income strategy, it’s prudent to understand what an annuity does and what it doesn’t do.

Essentially, annuities are insurance contracts. They are built to pay lifelong streams of fixed income, protect money from market losses, or offer tax-deferred money growth.

Indeed, billions of dollars sit in these contracts. A large part of that is due to their popularity for lifetime income, or for higher growth potential than with other low-risk interest-earning vehicles.

Nonetheless, there are still a number of myths and misconceptions about annuities. That might be attributable to a few factors, from annuities being fairly complex to misleading annuity marketing and sales tactics being touted.

This isn’t to say that annuities don’t have a place in a retirement portfolio.

Just like with any other financial vehicle, though, they must have a specified role. That can include solving for particular retirement risks, working in tandem with other parts of a portfolio to reach certain goals, or even simply providing peace of mind with predictable retirement income streams.

Let’s break down some annuity myths and misunderstandings, one-by-one, and learn more about them.

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should you buy an annuity when interest rates are low

If you are approaching retirement, chances are you have been started exploring how you might enjoy a financially confident retired lifestyle.

This includes maximizing the value of your retirement portfolio – and creating dependable income streams that last as long as you need them to.

For retirement investors, one way to solve for this concern is drawing on a lifetime income stream from an annuity. But how appealing are annuities in the face of historically low interest rates? Especially ones such as those we have experienced for the last several years?

Since 2009, in the aftermath of the Great Recession, most developed countries have experienced a low-interest rate environment. Monetary authorities have sought to use low-interest rate schemas in order to spur economic growth and prevent deflation.

The U.S. saw rates cut to effectively 0% until 2016, when they began to inch higher. Still, today, the federal funds rate is only 2.5%, up just half-a-point from this time last year when it measured 2%.

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annuity inflation risk img

“Inflation is as violent as a mugger, as frightening as an armed robber, and as deadly as a hit man,” Ronald Reagan once famously said.

And the worst time to try to fight this formidable foe is when you are in retirement, living on a fixed income. Many people have some employment, or some involvement with entrepreneurship, for a stream of retirement income.

But chances are they don't offer wage increases, or other inflation-countering benefits that you might have had in your working years, to help you keep pace.

Annuities are one of the few ways to obtain retirement income that is paid out as long as you live, making them a popular component of many retirement plans.

Investors have been using fixed annuities and fixed index annuities to provide lifetime income. These guaranteed income streams cover monthly costs and help people maintain their standard of living.

But if the annuity payout is fixed at the outset of the contract, by design it can’t be increased to keep pace with inflation. Should inflation rise 10% over time, for example, the buying power of a $3,300 monthly annuity payout erodes to $2,970.

This threat has the potential to affect a retiree’s lifestyle and could even require making unwelcome cuts in spending.

So how can investors seeking the benefits of annuities manage this inherent “inflation risk” and offset its impact? These are just a few of the ways.

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market value adjustment how it works

Have annuities ever popped up on your retirement-planning radar? You might have come across some annuity contracts with a Market Value Adjustment feature. Several fixed index annuities and multi-year guarantee annuities (MYGAs) include this factor in their contracts.

A market value adjustment (MVA) simply refers to the ability of an insurance carrier to offer you higher rates by protecting itself against bond market declines. When an annuity has a market value adjustment in its contract, it’s called a market value adjusted annuity (or MVA annuity for short).

Normally the insurance company holds the interest-rate risk when you buy a fixed annuity. But an MVA annuity gives you the chance to earn a higher rate in exchange for sharing in some of that risk with your insurer.

After all, bond values are sensitive to interest rate movements. So one way to think of this is as a “safeguard” for the insurance carrier against bond market losses.  

If an MVA annuity happens to fall into your retirement purview, here’s a helpful look at what it might involve.

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