Annuities are meant to ease people’s concerns about running out of money and give them a reliable income stream during retirement. Some investors may turn to an insurance company or other financial institution to purchase an annuity contract since more than these assets might be needed to maintain their living level.
Investors buy or invest in annuities with lump-sum payouts or monthly premiums. The holding institution pays the annuitant a stream of payments for the duration of their life or for a predetermined amount of time. Annuities assist people in managing the risk of outliving their assets and are primarily used for retirement.
Because of this, investors who seek steady, guaranteed retirement income—referred to as annuitants—should consider these financial products. Younger people or those with liquidity demands shouldn’t use this financial product because invested cash is illiquid and susceptible to withdrawal penalties.
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Particular Points to Remember
There is typically a surrender term for annuities. During this period, a portfolio tracker can help you monitor your funds, which could last for several years; annuitants are not permitted to withdraw without paying a surrender charge or fee. Investors in this time frame need to take their financial needs into account. An evaluation of the investor’s ability to pay required annuity payments might be prudent, for instance, if a big event, like a wedding, calls for large sums of money.
In addition, contracts contain an income rider that guarantees a fixed income following the start of the annuity. When thinking about income riders, investors should ask themselves two questions:
- At what age do they need the income? Depending on the duration of the annuity, the payment terms and interest rates may vary.
- What are the fees associated with the income rider? While some organizations offer the income rider free of charge, most have fees associated with this service.
Types of Annuities
Deferred and Immediate Annuities
Annuities can be set up as deferred benefits or start as soon as a lump sum is deposited. As soon as the annuitant deposits a lump sum, the immediate payment annuity starts to pay. Conversely, deferred income annuities do not start making payments until after the original investment. Instead, the customer designates a starting age for when they want to start getting payments from the insurance provider.
Annuity Critiques
Annuities are criticized for being illiquid. Annuity contract deposits are usually locked up for the surrender period, during which the annuitant would be penalized if any part of the money were to be touched. Depending on the product, these periods can extend from two to over ten years. The surrender cost usually decreases yearly over the surrender period and may begin at 10% or more.
Life Insurance vs Annuities
The two main categories of financial organizations that sell annuity products are investment and life insurance businesses. Annuities are a logical hedge for life insurance firms’ insurance offerings. The purpose of purchasing life insurance is to manage mortality risk or the possibility of passing away too soon. The insurance firm receives an annual premium from policyholders, who then receive a lump sum payment upon death.
Key Takeaway
In general, annuities can be set up as variable or fixed instruments. Fixed annuities are frequently utilized in retirement planning because they give the annuitant consistent monthly payouts. With variable annuities, the owner might expect to earn higher future payments if the annuity fund’s investments perform well and lower future payments if they do not. Compared to a fixed annuity, this offers less consistent payment flow, but the annuitant can still benefit from high investment returns from their fund.