With a fixed annuity, you’ll know ahead of time how much your payments will be once you start withdrawing. With a variable annuity, the performance of the market will affect the amount that your annuity pays out.
A fixed annuity is a financial product designed to support a comfortable financial life after retirement. It pays out a fixed stream of monthly, quarterly, semi-annual, or annual payments to an individual and is typically used as a source of retirement income. It has its comparative benefits, but generally speaking, an annuity may be a reliable way to help you reduce the risks of running out of money in retirement.
But is an annuity right for you? And if so, when should you start thinking about buying one? Breaking down the trade-offs of opting for an annuity versus other options can give you the information you need to become an informed annuity buyer.
What separates an annuity from a 401k or other investment products for retirement? Acquiring an annuity is a common way to fund retirement but works much differently than a 401(k). So, which retirement product is right for you?
A 401(k) is an investment account, typically acquired through your employer. A fixed amount of tax-deferred income is deducted from each paycheck and added to your retirement savings. In many cases, your employer will match your investment up to a predetermined amount. With a 401k plan, your retirement funds are finite. When you use up the money in your 401(k) account, there is no more.
Annuities differ in that they are designed to provide an income stream that can last as long as both spouses lives. When buying an annuity, you’ll have to make two critical decisions:
With a fixed annuity, you’ll know ahead of time how much your payments will be once you start withdrawing. With a variable annuity, the performance of the market will affect the amount that your annuity pays out.
With an immediate annuity, you start collecting payments as soon as you purchase. An immediate annuity will not allow for compounding but is designed for someone looking for an immediate payout. A deferred annuity means that you don’t start collecting on the annuity before a specific date. A deferred annuity allows your contributions the opportunity to compound in the meantime.
These decisions will hinge on a variety of factors, including your age when you purchase the annuity, other retirement accounts in your name, and the level of risk you’re willing to expose your investment too.
There are many benefits of purchasing an annuity, but they aren’t right for everyone. This type of retirement product is designed to provide lifelong income that can be guaranteed, especially if you choose a fixed annuity. It’s also tax-deferred, meaning that you only pay taxes on the money in an annuity as it’s paid out to you. During the deferral period, there isn’t taxation.
There are also limitations and risks involved with annuities, including giving up asset liquidity. When buying an annuity you are locked into payment installments and cannot recover any remaining annuity funds in a lump sum once you annuitize (start receiving the payout). Additionally, if your annuity provider goes insolvent or you die before the annuity has matured, the remaining funds could be lost.
Annuities can have very high commissions associated with them, and because of this, there have been situations where these products have been sold in the wrong circumstances. At Instrumental Wealth our advisors utilize commission-free annuities and generally don’t have some of the long surrender fee schedules that you can see with other products.
The right annuity buyers are the people who want a reliable stream of income*. They simply want a stable income that won’t run out, no matter how long their retirement may last.
*Reliable stream of income is dependent on the issuer’s ability to make payments.
Ultimately, the many variables involved in planning your retirement make a one-size-fits-all answer impossible. You can use a tool like an annuity calculator to estimate how much an annuity will help provide for your financial needs later in life.
Be aware, though — while annuity calculators are tools that can give you a broad estimate of future income, we would recommend working with a qualified financial planner with a deep familiarity with your unique circumstances to help you navigate your retirement. We can help set you up for success by offering expert comparisons of the different retirement investment products, monitoring fixed annuity rates, and more.