Learn About Annuities
Annuities come in several variations but the types of annuities that can play useful roles in retirement and retirement planning are really only fixed or fixed index annuities. Variable annuities are not good solutions for most investors.
Annuities in their simplest definition are contracts between individuals and insurance companies, wherein the individual pays a sum of money to an insurance company in the expectation of immediate or future benefits which usually take the form of an income stream.
Employers have been phasing out pensions for nearly a generation, leaving a major hole in the retirement planning of many Americans.
Fixed Annuities or Fixed Index Annuities (“FIA”) can fill that hole by replacing the guaranteed income stream from a pension with a guaranteed income stream from an annuity.
What are the biggest benefits of Fixed Annuities and Fixed Index Annuities?
It’s simple, actually. They guarantee an income stream for life without risking stock market losses. There are several ways these types of annuities fit into an effective retirement plan.
For Affluent Retirees:
- Guarantee an income stream that is likely to grow and keep up with inflation.
- Reduce or eliminate the need to draw on an investment portfolio for living expenses.
- Reduce or eliminate Required Minimum Distributions from retirement investment accounts.
- Give investments longer time effective time frames for compounding, which gives better opportunities for higher returns.
- Help investors experience more freedom in discretionary retirement spending.
- Can increase the legacy assets for heirs due to extending investment time frames.
For Less Affluent Retirees:
- Secure an income stream that is likely to grow without being forced into the risks of the stock market.
- Peace of mind knowing there will always be an income to supplement social security.
- Take away the fear that an unexpected market crash will end retirement and force them back to work
What You Need To Understand About Fixed Annuities and Fixed Index Annuities:
- Make sure your annuity is backed by a financially strong, major insurer. In this case, bigger is mostly better.
- Understand that what’s important about the annuity you select isn’t just the interest rate you get, but the income that you pull out of the annuity. In many cases, annuities that advertise higher interest rates (8% Annuity!! Click Here to Learn More!) actually pay out less than annuities that credit your account at lower interest rates.
Here’s how it works. Annuities are typically separated into an accumulation account and an income account. What matters for your retirement is the income account, but what’s usually advertised is the rate paid on the accumulation account. That’s a lot less important than the payout rate on the income account.
Let’s say you are going to put $100k into an annuity and you are offered two choices. The insurance agent tells you the first pays 8% and the second 5%. What he doesn’t tell you, because he wants the quick sale or maybe even just doesn’t know because he isn’t a financial planner, is that the 8% annuity has a 4% payout rate, but the 5% annuity features a 4.5% payout rate.
Most people will hear 8% that pays out 4% and assume that’s better than 5% that pays out 4.5%, but it isn’t. Let’s pretend this is a Fixed Annuity and you start taking income payments after the first year.
Annuity 1: $108,000 x .04 = $4,320 annual payout.
Annuity 2: $105,000 x .045 = $4,725 annual payout.
Over 20 years the person that picked the 8% annuity will lose out on nearly $10,000 in additional income the person that picked the 5% annuity received.
You can see it’s important not to let an insurance salesperson tell you the best annuity for you is the one that pays the highest interest, because what’s important is WHAT YOUR ANNUITY PAYS YOU EACH YEAR, NOT WHAT INTEREST RATE IT EARNS!
More Annuity Tips:
- In general, the lower the fees the better. The best Fixed Index Annuities don’t have add-on fees at all – instead the insurance company makes their money on earnings from above the “cap” on your credited interest rate. In English – you get everything below X percent, the insurance gets everything above. In almost all cases, this structure is better than a “spread fee” where the insurer charges a fee no matter what happens in your annuity. Spread fee annuities are often in the 2% area and many times, but not always, accompanied by an additional rider or admin fee that can be another 1% or more. In many cases, it’s better to look for a capped structure rather than paying direct fees to the annuity provider.
CLICK HERE to learn about common Annuity Myths.
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