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An annuity is an insurance contract that supplies a specific amount of income for an individual’s lifetime or a set amount of time. Annuities can be purchased with one large sum or through a series of payments, and the payout can begin immediately or at a later point. Many people use annuities for retirement funding.
Key things to note:
Annuities are insurance products that are customized to offer consumers a guaranteed source of income for life. They are legally binding, written agreements between the consumer and the insurance company that supplies the contract. The annuity transfers longevity risk — the risk that you may outlive your savings — to the insurance company. In exchange, you are required to pay the premiums that are listed in your contract.
Annuities convert a lump-sum premium into a regular source of income that an individual can’t outlive. Many people who have retired need more than investment savings and Social Security to cover their daily needs – this is where annuity investment comes in.
The way that an annuity supplies funds is through a process of accumulation and annuitization. However, in the case of immediate annuities, there is no accumulation period necessary, instead, guaranteed lifetime payments from the insurance company begin within a month of purchase.
When you purchase a deferred annuity, you provide a premium to the insurance company, and that first investment will grow tax-free during the accumulation period – this is determined by your contract conditions and is usually somewhere between 10 to 30 years. You will start to receive payments once the annuitization phase begins.
Annuity investment contracts remove the risk of fluctuating market trends from you to an insurance company, meaning that you are fully protected from longevity and any market risk.
To balance this risk, the insurance company will charge fees for administrative services, investment management, and contract riders. The annuity contract will also have a surrender period where the contract holder will not be able to take money from the annuity without incurring a surrender charge.
Additionally, the insurance company will establish spreads, caps, and participation rates on any indexed annuities, all of which can lower your return.
Free-Look Period
The majority of states require insurance companies to provide a free-look period to give buyers the chance to cancel their contracts without having to pay surrender charges.
Riders
Riders are add-ons that allow you to customize a general annuity contract. Make sure you understand the riders you choose and know their additional costs.
Beneficiaries
You can include a death benefit rider to your annuity contract to make sure your beneficiary gets a part of the contract value.
Fees and Commissions
Annuity fees and commissions are determined by the kind of annuity you have. Usually, fixed annuities have the lowest fees.
Taxation
Annuity investments are popular because of their favorable tax treatment from the IRS. If you bought an annuity with money that was already taxed, then you’ll only be taxed on the earnings when the money is withdrawn.
Annuity examples include immediate and deferred, and the one you decide to go with will be dependent on your financial goals. If you want to start receiving income right away, you need to select an immediate annuity.
However, if you’d like to wait to receive payments until a later date, you will need to choose a deferred annuity and determine a start date in your contract.
INCOME NOW
INCOME LATER
There are different kinds of annuities to fit various needs. Your personals needs and goals will determine the annuity that is best for you.
GUARANTEED INCOME
GROWTH POTENTIAL
FLEXIBLE INCOME
The main reason people purchase annuities is for long-term care income. While most people only think of annuities for retirement, an annuity investment is financially beneficial at any age.
Reasons to purchase an annuity:
Income annuities are best for people who are a year away from retirement and would like to have the security of an income stream. It’s important to note that single premium immediate annuities (SPIAs) start to pay within a year of being purchased, which means there is no accumulation phase.
Because of this, SPIAs are beneficial for younger people who have inherited a large amount of money and would like to secure the windfall from poor financial management.
Alternately, deferred annuities are not suggested for individuals who have shortterm financial needs or younger people who have aggressive investment strategies.
One of the main benefits of an annuity is the ability for an investor to save money without having to pay taxes on the interest until a future date. While IRAs and 401(k)s have contribution limits, annuities do not.
Additionally, annuities provide a guaranteed stream of income that can fund retirement, eliminating the fear of outliving your savings – a huge advantage in the post-pension age.
To figure out if you should invest in an annuity, look at your lifestyle and personal finances and see what aligns with them.
Tax-Deferred Growth
You save money and won’t pay taxes on the interest until a future date.
No Contribution Limits
Unlike IRAs and 401(k)s, you get to decide the exact amount you want to invest.
Fund Your Retirement
Annuities provide a guaranteed stream of income for life.
Provide for Your Family
Death benefit riders let you transfer money to your beneficiaries.
Some people consider sacrificing liquidity in exchange for a lifetime of financial security a disadvantage. If your short-term goals and financial standing limit how much money you have, then an annuity may not be best for you. It would not be in your best interest to buy a viable, valuable product if it is not viable or valuable for you.
Some common concerns about annuities include:
The term “opportunity cost” is the loss of potential returns, and many people consider this a drawback – this makes sense for individuals who have a higher risk tolerance. For instance, a young investor has more time for their money to grow and recover from market loss so they could benefit from more aggressive investments strategies.
Alternatively, retirees and older investors need to evaluate opportunity costs against their personal circumstances. People in this age bracket usually don’t consider opportunity costs a disadvantage to an annuity.
For many individuals, the main drawback to annuities is losing access to their funds for the duration of their contract. The reason being, not only do they risk the possibility of not having funds to cover unexpected needs, but they could also miss out on better interest rates or the chance to invest in the stock market.
This is where you have to look at your long-term goals and decide if buying or selling an annuity fits into your plan. You should also make sure you’re comfortable with not having access to your money in exchange for a lifetime stream of income.
To lower your opportunity cost, think about doing a partial investment upfront; this lets you reserve a portion of your savings for unexpected expenses while also giving you the opportunity to take advantage of higher interest rates.
To get started, contact us now. We’ll connect you with our partner, Senior Market Sales, for more information on protecting your financial future.
Wall Street Financial Group, Inc., an Illinois corporation, is a Registered Investment Adviser in the states of Illinois, Missouri, and Tennessee. Carl Zeidler and John Zeidler offer investment advice through Wall Street Financial Group, Inc.
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