How do annuities work and can you rely on them for your retirement income? Learn more about the types of annuities here!
In this article:
- What Are Annuities?
- Insurance, Not Investments
- Why Retirees Don’t Utilize Annuities
- The Types of Annuities
- Questions You Should Ask
How Do Annuities Work to Give You Income Forever?
What Are Annuities?
It’s safe to say that monthly income is the first thing on a person’s mind when they think about retiring.
Many American retirees lay awake at night worrying about outliving their income.
Others planning for retirement are concerned that they won’t have enough saved to live comfortably.
That’s why I want to introduce you to a very popular — and profitable — strategy to create your retirement nest egg.
Enter annuities. They’re efficient, safe, and tax-deferred!
But unfortunately, they’re not the easiest tool for most retirees to figure out, which is why today I’m giving you a crash course on annuities so you don’t have to sit out on the action!
Insurance, Not Investments
While you might think of annuities as an investment, they are more like insurance.
Here’s a little history lesson for you: Annuities date back to the Romans.
The Latin word “annua” meant annual stipends. And during the Roman era, individuals would make a single large payment into the annua and then receive an annual payment each year until death.
Annuities gained popularity after the 1929 stock market crash.
Investors sought safe havens for their hard-earned money and were afraid of another stock market crash taking away their savings.
Today, annuities account for more than $200 billion of Americans’ savings.
Here’s how they work.
At their simplest, annuities offer a guarantee.
If you turn over some money, you’ll be guaranteed to get all that money back — and usually a certain amount more. Or you can turn over some money, and you’ll be guaranteed a regular check for a specified period — even a lifetime.
They’re as simple as that.
Why Retirees Don’t Utilize Annuities
Are annuities a good investment for retirement? Based on the simplicity of how to do annuities, it should be a popular option for retirees.
And yet, annuities are not as popular or as utilized as they need to be. Why is that?
There are two main reasons:
- The annuity product lineup has become so filled with complex offerings trying to solve every problem and answer any objection that people just become confused.
- The insurance companies that sell them have outsourced annuities to salespeople who don’t always have customers’ best interests at heart.
Annuities aren’t a one-size-fits-all vehicle.
You have to get the annuity that best suits your unique needs. If not, you could end up on the losing end of the bargain while the insurance company who sells it to you ends up on the other side.
Remember this: While annuities are low-risk for you, the insurance company selling you an annuity is still trying to make money off this transaction.
So instead of wondering to yourself, “How do annuities work?” and weighing the pros and cons of annuities, you should figure out what type you should be investing in.
You either make a good choice for yourself (which can be bad for them), or you make a bad choice (which is good for them).
So if you make a bad choice in your annuity, they may not even correct you. Instead of getting the best annuities for your needs, a bad choice will result in a whole host of problems for your retirement income in the future instead.
The clear solution is to understand your options going in. And choosing the right annuity could be the best retirement move you could ever make.
The Types of Annuities
Let’s take a look at the major types of annuities.
1. Paycheck Annuities
These are the simplest form of annuities, and they’re similar to a pension. You hand over a pile of money and in exchange, you can receive a regular check for life.
Paycheck annuities can be of two types — either immediate or deferred income annuities.
How do immediate annuities work?
An immediate income annuity generally starts sending checks very soon and they keep coming as long as you live. The size of your annuity will depend on several factors — the initial amount you deposit, your age, your gender, whether you’re including a spouse in the package, and the prevailing interest rates at the time you buy the annuity.
What about deferred annuities?
In deferred income annuities, the checks don’t start coming right away. But the longer you wait to receive payments, the bigger the checks will be.
2. Fixed Annuities
Fixed annuities are similar to paycheck annuities in that you hand over a lump sum to start with.
The difference is that the money grows for a predetermined period at a “fixed” rate. Then you can turn it into a regular check for life if you’d like.
If you think how fixed annuities work fits what you need for your retirement plan, then you can find out more about this type from your insurance agent.
3. Variable Annuities
Variable annuities are for people who want to have their cake and eat it, too. They can offer a guaranteed check (called a baseline minimum) for life.
But variable annuity buyers can get more money than the baseline minimum depending on the performance of certain mutual funds.
So whereas paycheck and fixed annuities do not give their owners access to the stock market, variable annuities come with “sub-accounts” that do.
But be warned, the fees for these sub-accounts can be high. That’s just how variable annuities work.
4. Equity Indexed Annuities
The last type of annuity is the equity-indexed annuity.
In this type, you still receive a guarantee you’ll get your money back. And if the equity index that it references — say, the S&P 500 — goes up, the annuity company will credit a portion of that gain to your account.
While that might seem like an advantage, the overall amount you get in any year might be subject to a cap and additional costs.
Once you’ve understood how indexed annuities work, you can decide whether you want to risk investing your money into the annuity company.
Questions You Should Ask
Even within the major types of annuities, insurance companies keep adding bells and whistles to tempt you to buy their products.
So it’s important to know how do annuities work before you finalize any type of deal with your insurance agent.
Make sure to ask a ton of questions before you sign on the dotted line.
Here are a few questions you should ask…
- What happens if I suddenly need some or all of my money back?
- What happens with the annuity if I die?
- What taxes will I pay?
- What are the circumstances under which I might not get back my money?
- Will the contract change after a few years?
- What can change during the term of the contract?
- What part of the contract decides how much money I eventually receive?
- Is there any possibility that payments could increase with inflation?
- Must I take a monthly or other regular payment at any point during the term of the annuity, or is it merely an option?
- Can you please provide a list of all the fees I’m paying?
These questions are easy enough to understand. If the replies aren’t equally simple, or if you are not satisfied with the answers, you should walk away.
Make sure you understand the type of annuities you want to get and whether or not you can get the best results out of it. After all, it’s for you and your family’s security in the future.
Because the truth is, if you make the right choice, you’ll be happy for a lifetime. If not, the opposite is true. And we don’t want that!
Do annuities work for your retirement plans? Share your thoughts about how annuities work for you in the comments section below!
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