What is an Annuity

What is an Annuity

Most people think their greatest financial challenges in life are purchasing a home and getting their children through college, but what if there were no such things as student loans or mortgages?  How many of your children would have still gone to college?  How many of you would have owned a home?  For most people, retirement lasts longer than four years and costs more than the average home … and yet you can’t take a loan out for it.  Most of us are counting on Social Security, a 401(k), an IRA and/or whatever savings we have to fund our golden years, but is there any way to supplement your retirement package and replace the steady income provided by a job? Yes, it’s called an “annuity.”

To begin to understand annuities, it helps to think of them as houses that come in two basic models – income producing and wealth generating.  Let’s take a look at income producing annuities first. Income annuities are designed to provide you with a guaranteed income. They can start paying you right away (called an “immediate” annuity) or wait until a future date set by you (called a “deferred” annuity). They can provide you with a fixed stream of income for the rest of your life or a specific period of time, no matter how the market performs. As you can see, income annuities offer a lot of flexibility and options for design, much like a home builder’s choice of features. Like designing a house, you can design an income annuity to fit your specific needs.

Wealth accumulation annuities are structured differently as they are designed to protect your money from stock market losses while still allowing your money to grow with stock market gains. It’s like locking both your front and back door when you go to sleep at night. Unlike wealth accumulation annuities, if you have your money in stocks or mutual funds; the front door may be locked but the back door isn’t and when the markets falls, your gains go out the back door. Where traditional retirement accounts rise, and fall in value with the market, the value of a wealth accumulation annuity only goes up. When the market goes down, all the doors of a wealth annuity are locked to protect the value already accumulated inside. The catch with wealth annuities though is that when the market goes up you participate in those gains, but not all of the gains. While this may initially be a turn off for some, keep in mind when the stock market falls, you have a floor of zero and won’t subject your savings to stock market losses.

Within both income and wealth annuities, there are three investment strategies to consider for how your money grows: variable, fixed, and indexed.

A variable annuity offers you the greatest control over your investments.  Much like selecting mutual funds inside your 401(k), you have the option of placing funds in whatever investments are offered by an insurance company. The performance will be tied to an underlying investment like mutual funds, for example, the value of your annuity will rise and fall with the performance of your investments.  Honestly, I’m not a fan of variable annuities because of the high fees, and subjecting your account to market losses. I don’t see a need for them as an investment option.

In contrast, a fixed annuity might be a good choice for someone who has little knowledge or experience with investing. It puts the risk on the insurance company’s shoulders instead of yours and safeguards your money against market fluctuations by providing a fixed rate of return, similar to a bank CD.

Lastly, an indexed annuity offers the best of both worlds. It combines the guaranteed minimum interest rate of a fixed annuity with the potential for growth (similar to a variable annuity) with protection.

Finally, the old days of insurance companies keeping your money after you pass are long gone. With income riders and lump-sum distribution options, annuities are even more attractive and financially smart for passing your remaining annuity balance to your heirs. Make sure to inquire as to what happens to your annuity when you pass.

Hopefully, you now have a better understanding of what annuities are and how they can work for you.  As with all investment decisions, a little bit of research can go a long way in empowering you to make good choices regarding your retirement.  Make sure to view our other annuity articles and stories, and consult with our advisor network to be better informed.

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