Annuities, insurance products issued by insurance companies, are often recommended by insurance and financial professionals to investors. They are designed to provide a steady income stream in retirement. While they come with benefits, they also have drawbacks that investors should consider. This article aims to provide comprehensive information on annuities so that investors can make an informed decision before purchasing one.
What is an annuity?
An annuity is a contract between an insurance company and the contract owner. In exchange for premium payments, the annuity insurance company agrees to pay an income stream to the contract owner beginning at a specified date. Annuity payments may be paid in one lump sum or through several payments over time.
There are various types of annuities, including fixed, fixed-indexed, and variable annuities. Each has varying levels of risk, so it's vital to meet with an insurance or financial professional to understand each annuity type fully.
Benefits of annuities
There are various annuity benefits that investors may find suitable to their situation. Insurance and financial professionals can discuss these benefits with you in more detail when sourcing annuity insurance products. Here are some of the more common annuity benefits.
Income stream for a certain period—One benefit of annuities is their ability to provide a guaranteed income stream for a specific period or the rest of the investor's life. This steady income stream can give a sense of security and independence, especially for those concerned about outliving their retirement savings. Annuities can also offer tax-deferred growth, meaning that any earnings on the investments within the annuity are not taxed until withdrawn.
Creditor protection—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.
Annuity riders—Annuity riders come at an additional cost to your annuity contract premium. Some examples of riders include:
Inflation or COLA 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. Also known as a cost-of-living adjustment rider or COLA rider, this feature adjusts your annuity payments annually to help them 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.
Death benefit rider—This rider provides a guaranteed death benefit to the beneficiary, regardless of the amount left in the contract.
Drawbacks of annuities
Annuities have drawbacks that investors must consider and may not be suitable for everyone. A financial professional can help determine if an annuity is an appropriate retirement savings strategy for you.
Expenses and fees—Annuities may come with high fees and expenses. It's crucial for investors to thoroughly understand and consider the costs associated with an annuity, as these fees can significantly reduce the overall return on investment. Additionally, annuities can be complex and challenging to understand, making it essential for investors to carefully read and comprehend the terms of the annuity before committing.
Lack of liquidity—Another potential downside of annuities is their lack of liquidity. Once the investor commits to an annuity, accessing the invested funds without incurring significant penalties can be challenging. This lack of liquidity can be a major drawback for individuals needing access to their funds in an emergency.
Surrender charges—A surrender charge may be applied when you withdraw or surrender the annuity policy before the surrender period. Surrender periods can vary, with some lasting five to eight years. A financial professional can help you understand how surrender periods work with specific annuity policies.
In conclusion, annuities can be a suitable retirement savings strategy for investors seeking a steady income stream. However, it's essential to work with an insurance or financial professional to carefully weigh the pros and cons before investing in an annuity. Understanding annuities' benefits, drawbacks, costs, and fees is crucial for making an informed decision that aligns with your retirement income needs.
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Disclosure:
This information is provided as general information and is not intended to be specific financial guidance. Before you make any decisions regarding your personal financial situation, you should consult a financial or tax professional to discuss your individual circumstances and objectives. An annuity is intended to be a long-term, tax-deferred retirement vehicle. Earnings are taxable as ordinary income when distributed, and if withdrawn before age 59½, may be subject to a 10% federal tax penalty. If the annuity will fund an IRA or other tax qualified plan, the tax deferral feature offers no additional value. Qualified distributions from a Roth IRA are generally excluded from gross income, but taxes and penalties may apply to non-qualified distributions. Consult a tax advisor for specific information. The sources used to prepare this material are believed to be true, accurate and reliable, but are not guaranteed.
Disclaimer:
Information provided is for informational purposes only, and does not constitute an offer or solicitation to sell, a solicitation of an offer to buy, any security or any other product or service. Accordingly, this document does not constitute investment advice or counsel or solicitation for investment in any security. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation.