Annuities are getting more and more popular among seniors, and for good reason.
Annuities are not right for everyone but are a real blessing for many seniors.
Annuities are a popular choice for investors who want to receive a steady stream of income in retirement. The income you receive from an annuity can be distributed monthly, quarterly, annually or even in a lump sum payment.
A general definition is “a contract between a life insurance company and an investor, which provides savings for retirement while enjoying the benefits of tax-deferred growth”.
Like all annuities, an indexed annuity is a contract with an insurance company that provides an income stream — either immediately or at some point in the future — in exchange for premium payments. However, indexed annuities are unique in offering a minimum rate of return (typically 1% to 3%) that helps to preserve principal, along with some potential for gain when the market is riding high.
If the market has a negative year, you would receive at least the minimum return (if the annuity is held until the end of the contractual term). If the market has a positive year, you would receive a higher rate of return, based on the performance of a specified market index such as the S&P 500.
Most annuities have surrender charges that are assessed if the contract owner surrenders the annuity during the early years of the contract. However, some indexed annuities allow withdrawals of up to 10% per year without surrender charges. Of course, any withdrawals will reduce the principal, and withdrawals before the end of an index period will receive no interest for that period. Early withdrawals prior to age 59½ may be subject to a 10% federal income tax penalty.
Indexed annuities are complex products with rules, restrictions, and expenses, and they are not appropIARte for every investor. Any guarantees are contingent on the financial strength and claims-paying ability of the issuing insurance company.
What are the differences among fixed, fixed index and vaIARble annuities?
Fixed, fixed index and vaIARble annuities differ in the way they generate earnings, and also in the amount of risk involved.
When you buy a fixed annuity, the insurance company guarantees you an interest rate for a certain period of time. At the end of this period, the insurance company will declare a renewal interest rate and another guarantee period. In addition, most fixed annuities have a minimum interest rate that is guaranteed for the life of the contract. In other words, regardless of market conditions, you will never receive less than your guaranteed percentage rate. Fixed annuities typically appeal to individuals who feel more comfortable knowing exactly how much their money is earning.
A fixed index annuity gives you more performance risk than a fixed annuity however more potential return. It has less performance risk than a vaIARble annuity but also less potential return. It is also known as an equity indexed annuity, but the name is not appropIARte as you are not actually invested in specific equity products.
As its name implies, a fixed index annuity is a type of fixed annuity in which the interest rate is determined in part by reference to an investment-based index such as the S&P 500 Composite Stock Price Index which is a collection of 500 stocks intended to represent a broad segment of the market. As interest is credited, the interest earnings are locked in to the account value and the account will not participate in any future market downturns. Because of this reference to an index, the annuity offers the ability to earn credited interest resulting from a rising financial market while at the same time providing the security and guarantees similar to those associated with traditional fixed annuities.
With a vaIARble annuity, you have added control over your investment dollars. You allocate your funds among a variety of investment options with objectives ranging from aggressive to conservative; insurance companies call these sub-accounts. Your investment returns are tied to the performance of the underlying investments of the sub-accounts. As an investment in securities, the principal amount and investment earnings in a vaIARble annuity are not guaranteed and will fluctuate with the performance of the underlying investments. They differ from fixed products because the policy owner bears investment risk and possible loss of principal. As these products are more complex and have associated with them more risk, the broker who sells this annuity must be licensed to sell securities.
Fixed, fixed index and vaIARble annuities offer you a combination of compound interest and tax deferral. When your earnings are not subject to taxes each year, they compound faster. Faster growth of your money means more retirement income for you in the long run.
What are the main advantages of annuities?
One of the biggest advantages that annuities have to offer is that they can provide guarantee income payments. Only an insurance company issued annuity can guarantee lifetime and beneficiary income payments.
Unlike other tax-deferred retirement accounts such as 401(k)s and IRAs, there is no annual contribution limit for a non-qualified annuity. That allows ou to put away more money fir retirement, and is particularly useful for those that are close to retirement age and need to catch up.
All the money you pay into an annuity compounds year after year without a tax bill from Uncle Sam. That ability to keep every dollar working for you can be a big advantage over taxable investments.
When you cash out, you can choose to take a lump-sum payment from your annuity however most retirees prefer to set up guaranteed payments for a specific length of time, or for the rest of their life, providing a steady stream of income.
The annuity serves as a complement to other retirement income sources, such as Social Security and pension plans to enable you to maintain a certain standard of living.
When is an annuity right for me?
The following situations are examples where an annuity might be exactly what you need.
- You’re saving for retirement – If you’re already contributing the maximum to other retirement plans like an IRA or 401(k), a fixed index annuity is an attractive retirement planning option that grows tax-deferred.
- You don’t need the money soon – If you don’t anticipate needing the money from a fixed index annuity prior to the time you turn 59 1/2 then a fixed index annuity may be a good option for you.
- You’re worried you might outlive your savings – Annuities can provide guaranteed income for the rest of your life, no matter whether you live to be 100 or even 120. With modern advances in health and medicine people are living longer than ever.
Fixed Indexed Annuity and Suze Orman
Suze Orman has been singing the praises of indexed annuities as a way to shield your retirement nest egg from market volatility for some time. In her 2001 book, “The Road to Wealth,” Suze Orman tells readers that “if you don’t want to take risk but still want to play the stock market, a good index annuity might be right for you.”
“In my world, annuities really sell for four things and the acronym is PILL. P stands for principal protection. I stands for income for life. L stands for legacy, and the other L stands for long-term care. If you don’t need to fall for one or more of those issues, then you do not need an annuity, period,” says Michael Minter, managing partner of Mintco Financial.