An annuity is a contract between an individual and an insurance company designed to provide a steady, guaranteed stream of income, primarily used for retirement planning. The individual (contract owner) makes a lump-sum payment or a series of contributions (premiums) to the insurer, which are then used to fund future payments to the owner. Annuities are particularly used to mitigate "longevity risk"—the risk of outliving one's savings.
Annuities generally operate in two distinct phases: Accumulation Phase: The period during which you pay premiums and the money grows, usually on a tax-deferred basis. Distribution (Payout) Phase: The period when you start receiving regular income payments, which can be for a fixed period or for the rest of your life.
Have you heard that annuities are bad? We have. The main reason is that other accumulation methods, such as stocks and bonds, can outperform annuities, and the lack of liquidity during th early years.
We NEVER recommend variable annuities.
So why do we often recommend annuities AS PART of an overall retirement strategy?
Single Premium Immediate Annuities (SPIAs) require a one-time lump sum premium payment in exchange for a lifetime income stream based on your life expectancy. Typically, these annuities offer a Period Certain option, which guarantees continued payments to a beneficiary if you do not live beyond the selected period. Income payments begin immediately upon purchase, and once the premium is paid, you no longer have access to that principal amount.
For a predetermined term, fixed annuities provide a guaranteed or flexible rate. The most popular is a five-year guaranteed rate, which can vary from 2.5 to 4% based on the state of the market at the time of purchase. In addition to offering a tax deferral option superior to CDs, fixed annuities are frequently used to grow money securely and at a rate many times higher than a bank.
You can choose a market-linked index with fixed index annuities without taking on any risk. Using a cap, spread, or participation rate, you will select an index that offers you a potential interest rate based on the index's performance. There are typically no fees and no market risks, though there are some exceptions depending on the product being offered.
Similar to mutual funds, variable annuities are directly invested in the market through sub-accounts. These are provided by brokers and come with significant fees, typically between 3.5 and 5% annually, as well as MARKET RISK. They are complex because they combine annuities and investments into a single, highly regulated product.
You have the opportunity to receive a lifetime income, which can be distributed either on a monthly or annual basis. It is noteworthy that most companies impose a fee; however, they also provide a guaranteed roll-up benefit along with a Long-Term Care feature that can be activated in the later stages of your life.
You can secure a market-linked growth rate of return without incurring market risk and with no associated fees*. Most carriers allow for an annual income withdrawal of up to 10% as needed.
*Please note that certain indexes may include an optional fee for enhanced index growth opportunities.
The issue regarding financial withdrawals during retirement is particularly pronounced in a declining market. During such periods, it can prove exceedingly challenging to recover from the adverse effects of market downturns, a phenomenon known as the Sequence of Returns Risk.