When it comes to retirement planning, annuities seem to be all the rage. As a consumer, it is hard to know what to believe because while some financial professionals think annuities are sent from heaven, others advise you to avoid them like the plague.
When making the decision about whether an annuity is right for you, make sure to ask yourself some important questions:
Do you understand it? In its simplest form, an annuity is a contractual agreement between you and an insurance company. You agree to give them money. They agree to give it back, over time. Your expectation is that they will invest it so that you can potentially get back more than you contributed. Many people identify with annuities because it has the familiarity of a paycheck. Nevertheless, they can be much more complex and elaborate. When making an annuity purchase decision, make sure you understand the insurance company’s promises, the limitations on access to your money, surrender charges, penalties, how it is invested, up-front and ongoing fees, and most importantly, the financial condition of the insurance company. Keep in mind that you pay the insurance company ongoing fees so that they can honor the guarantees they promised when you need the income. Make sure that they are in a position to make good on their promises before handing over any portion of your life savings.
How important is flexibility? If flexibility is one of your top priorities, then you may want to consider other options. Yes, annuities have come a long way in the past 20 years, and some even allow you to take lump sum withdrawals at your discretion. Nevertheless, some of the more traditional annuities, like the immediate annuity, do not have that option. Instead, once you purchase the product, there is no turning back. If you are the type of person who is likely to say “but it’s my money, why can’t I have it,” then begin looking for an alternative that does not have as many strings attached to its distribution options.
Is it important for you to leave an inheritance? Some annuities have a death benefit or a survivor benefit. Many do not and once you die, all benefits end. Before making an annuity decision, tell your financial adviser whether you want your spouse or heirs to benefit from anything left after your passing. Then, ask questions to develop a clear understanding of the beneficiary options for that contract. Death is a stressful time for loved ones, but your understanding of the death benefits can help alleviate the financial stress associated with this event.
Annuities are not appropriate for everyone, but there are situations when an annuity product makes sense:
• If you need a specific amount of income in retirement and know that you need to invest, but cannot stomach the constant fluctuations of the market, then an annuity may help. Some insurance companies offer annuity products that allow you to invest in the stock market, but use guardrails to protect certain components of your contract such as income withdrawals or the death benefit.
• Another condition is if you make the maximum contribution to your 401(k) and IRA, and want to contribute to another tax deferred account, then an annuity is an option. While there is no tax deduction for contributions, the investments inside the annuity can grow tax free. Then, when you request distributions (after age 59.5), you are taxed only on the earnings portion of your withdrawal.
Regardless of your final decision, make sure to consult objective financial professionals to help you weigh the benefits and drawbacks of this product within your overall investment and retirement strategy.
Life is a journey. Plan for it.