When an Annuity Is a Good Retirement Idea (and When It’s Not)

When it comes to planning for retirement , there is often confusion. While saving money to earn tax-deferred interest is a fairly simple concept, the wide range of ways you can do it can be dizzying, especially if you can’t count and have no experience in managing finances . But many people worry that just sticking with a pre-made 401k from their employer might not be the best approach, so they start looking for alternatives. Eventually, someone will offer an annuity.

And just as quickly, someone will rush to you to tell you in no uncertain terms that annuities are a bad idea. The growing controversy over annuities boils down to two simple facts: annuities can be complex, and they’re not for everyone. But if you’re taking a more active role in your retirement planning, an annuity might be worth considering. Here’s what you need to know.

Types of annuities

The first question everyone has when it comes to rent is: what the hell is rent? You may know that an annuity pays you some kind of guaranteed income – this is the main advantage when it comes to retirement planning. But an annuity is not so much an investment or investment package (like a 401k or an IRA) as it is investment insurance . First, you pay the company a lump sum or a series of payments and agree to let them manage it for a set period of time (known as a “buildup period”). When the “annuitization period” begins, they guarantee a certain return no matter how the market goes. If the economy goes down, your IRA will go down with it (at least for a while), but the annuity will continue to pay out.

This is a simplified version – it gets more complicated because there are several different types of annuities:

• Fixed. With a fixed annuity, you pay in a lump sum or in a scheduled series of payments, and you know from the outset what your income will be – the annual or monthly income that you will receive from it over the term of the contract (for example, ten years) – usually from the very beginning start. Some fixed annuities guarantee the amount of income only for a certain period of time, while others guarantee it for the entire period. If this income is guaranteed for the whole term, this income is fixed and does not change, no matter what happens to the principal or interest rates. One obvious disadvantage of a fixed annuity is that inflation and other factors can make this income insufficient in the long run.
• Variable. With a variable annuity , the income you receive back after the start of the annuity period depends on the performance of the investment package you choose. There is more risk here because your income could plummet, but some variable annuities offer an additional minimum income clause that you can pay for to reduce that risk.
• Instant. Most annuities have a deferred annuity period, meaning it doesn’t start paying you income for a fixed period of time. But you can purchase an annuity product that starts paying you very quickly , usually within a year, which can be attractive if you’re already retired and want a secure income as a hedge against volatile market forces.
• Lifespan. Most annuities have a term, a period of time during which the insurer agrees to pay you income. A lifetime annuity only ends when you do, and even then you can often buy a racer who will pay income to a spouse or partner after you die. These annuities usually have a significantly lower rate of return due to the additional risk the insurer takes on.

Pros and cons

Buying an annuity seems pretty straightforward – for a certain amount of investment, you get a stable, sometimes guaranteed income for a certain period of time or even for the rest of your life. Retirement comes with a lot of uncertainty, especially when it comes to your investments and whether they will meet your needs as you age, so this is a comforting idea.

And there are several good reasons to consider an annuity:

• Stability. Knowing that your income has a “floor” that won’t change is incredibly helpful, even if inflation or other living expenses go up.
• Deferred tax. During the accumulation period of your annuity, your money usually grows from deferred tax.

But there are some downsides to consider:

• Expensive. Annuities usually require a fairly large down payment; annuities typically cost around $100,000 in investment, with $500 in monthly income after retirement age. And your investment is not insured by the Federal Deposit Insurance Corporation (FDIC), so the only guarantee that you will receive the money is the existence and good management of the insurance company from which you buy the annuity. In addition, there are many fees associated with annuities. If you try to withdraw your money before the accumulation period is over these fees can be staggering and annuities typically charge high maintenance fees that can sometimes be as high as 10% of the value of your investment and the fee structure is often difficult to understand.
• Taxes. The accumulation period may be tax-deferred, but the income you receive will be taxed —and it will be taxed like ordinary income. This means it will be a higher tax rate than what you pay on your capital gains, so you may be in for a shock when the tax bill arrives.
• Difficult. Perhaps the biggest gripe with annuities is their complexity: you often have to sell annuities hard, and the sellers often try to “bring” them for a guaranteed income. But contracts can be tight and it’s hard to quantify whether you’re getting a good return on your investment or not.

So, should you consider an annuity? This is a tricky question, and each person’s financial situation is unique, but you should probably only consider one of them if you answer yes to both of the following questions:

1. Do you have extra money? I’m not kidding. If you’ve already deposited the maximum amount of money in other tax-deferred retirement accounts such as 401k and IRAs, and you still have a ton of money burning a hole in your bank accounts, an annuity might be a good way to put that money in. work in an additional vehicle with a tax deferral.
2. Are you very risk averse? The main advantage of an annuity is its predictability. If the ups and downs of your retirement accounts make you feel sick, having an annuity can ease some of that stress.

If you “no” on them, you probably don’t need or want an annuity. If you’re unsure, calculate what the worst-case scenario for your retirement income, including Social Security, is likely to be. If that’s still enough to cover your expenses, your money will probably do more for you in another investment.