Could annuities be a good investment for retirement? If you could have more peace of mind or your plan could be stronger from having contractual guarantees in it, such as guaranteed income for life, then it’s good to consider an annuity.
What about saving for retirement? If you are taking advantage of contributions to retirement accounts, then annuities can provide another tax-advantaged vehicle for you to build up even more retirement savings. These are just a few ways that an annuity might help you in your financial goals.
One Important Clarification
All of that being said, let’s go back to the original question: “Are annuities a good investment for retirees?” To delve fully into that, it’s important to be clear about what annuities are.
By definition, an annuity is a contract with an insurance company. In exchange for someone putting money into the annuity contract, the insurance carrier promises to uphold contractual guarantees over a certain time. This might be a contractual guarantee to pay you a lifetime income stream, for example.
Because of this use as a contract, many annuities aren’t technically an investment. Fixed-type annuities such as fixed annuities, multi-year guarantee annuities, and fixed index annuities are really fixed insurance contracts. In this regard, they are more of a risk-managing tool.
A Quick Word on Variable Annuities
The odd man out is variable annuities, which are still contracts, but they come with investment features. The money that is put into a variable annuity is invested in a selection of mutual fund subaccounts.
These subaccounts are investment funds that can lose value when the markets decline. Because of those investment features, variable annuities are classified as both insurance and securities products.
Of all annuity types, variable annuities carry the most market risk. However, they also have the most growth potential of all the different kinds of annuities.
Fixed-type annuities are primarily a risk-managing tool rather than an investment. You can think of them as an alternative or a complement to bonds, CDs, money market accounts, and other similar interest-earning instruments. These annuities are usually appropriate for the fixed-interest parts of your retirement plan.
With investments, you are usually looking to take on a certain level of risk in exchange for higher growth potential. Fixed-type annuities do the opposite, insofar as they help you manage your exposure to market risk.
As part of your overall plan, fixed and indexed annuities can help your money earn interest while counterbalancing the risk of market loss that your investments may carry.
How Do Fixed-Type Annuities Earn Interest?
Fixed annuities can pay you a guaranteed interest rate for a year or a certain period of a number of years. This rate can be rather low, although it tends to be slightly higher than the rates paid by other instruments such as bonds or CDs.
A fixed index annuity can let your money earn interest based on an underlying financial benchmark, such as the S&P 500 price index. In this sense, the interest you earn isn’t guaranteed as you would earn with a fixed annuity.
However, the possibility for index growth means you can earn more interest with a fixed index annuity than you might with a fixed annuity. When the benchmark index goes up, your money will be credited interest that is based on a portion of that increase.
When the index goes down, then your money will simply be credited zero interest for that period. All of that said, fixed index annuities have historically earned more interest than fixed annuities on a broad scale.
In exchange for this principal protection, the insurance company limits the growth potential of your indexed annuity with caps, participation rates, or spreads. Your financial professional can help you walk through this.
Can You Lose Money in a Fixed-Type Annuity?
If you have add-on features for a guaranteed lifetime income or other benefits in your contract, you might be paying a rider fee for that benefit.
In the down-periods, the rider fee may eat into the zero-interest-crediting for that time. In those times, you might lose some money.
If you end the contract early before the surrender period ends, you might incur a surrender charge. However, this applies to all annuities, and it’s a means that helps the insurance company keep its long-term guarantees to you and many, many other annuity contract holders. Otherwise, your money is parked pretty comfortably in a fixed-type annuity.
A Monopoly on Guaranteed Lifetime Income
Annuities are the only financial vehicle available in the marketplace today that can guarantee you an income stream that you can’t outlive. In fact, besides Social Security they are the only thing on the planet that can give you a guaranteed lifetime income.
Annuities can essentially work as private pension plans in this sense. A survey conducted by Franklin Templeton revealed that 97 percent of pre-retirees are looking for a way to convert their retirement savings into income-producing vehicles. They want to know how much money that they will get every month or year.
Do Annuities Make Sense for Your Retirement Goals?
Whether annuities make sense for someone ultimately depends their financial goals, risk tolerance, tax situation, and timeline for their money.
Annuities aren’t for everyone. However, if the contractual guarantees of an annuity can help fill gaps in your plan, you might consider an annuity for your situation. Should you want to accumulate more money for your retirement income, annuities can also be a good complement to retirement accounts and other savings vehicles.
What Annuity May Be Right for You?
The type of annuity that fits your goals will depend in large part on your personal risk tolerance. For those who are “risk takers,” variable annuities may be something to consider. Fixed-type annuities may be a better fit for those who don’t have the stomach for market risk and financial losses.
Your financial professional can help you consider your personal situation and explore your options based on your goals. Consult them for more information on annuities and whether they are right for you.
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