There are multiple options for investors saving for retirement including employer-sponsored and self-employed pension plans, 401k or 403b plans, Individual Retirement Accounts (IRAs), and deferred annuities. Here is some information to help you understand retirement annuities and how they can fit into your financial plans.
What is an annuity?
Financial institutions, mainly investment and insurance companies, offer annuities to individuals as long-term investments for retirement savings. Someone can make a lump sum investment or monthly installments to fund an annuity. At some future date, the annuity contract will provide a reliable income stream to the individual. Social Security and defined benefit pension payments are classic examples of how annuities are intended to work.
It helps to understand the concept of fixed or variable and immediate or deferred annuities. A fixed, or lifetime, annuity provides a lifetime stream of income starting at a predetermined date and continuing until death. A variable annuity is popular as a way to defer some portion of income taxes. An immediate annuity takes a lump sum investment and converts it into payments that start immediately and continue for life. A deferred annuity can be funded with a lump sum investment but usually involves monthly investments designed to grow over time before being converted to the lifetime income payment stream.
Why should someone invest in an annuity?
There are few arguments against planning for and investing in your retirement. If there is a “con” to investing an annuity, it is that you give up a portion of today’s dollars to create a future income stream. The obvious benefit is that you create a lifetime future income that starts as soon as you retire. Another benefit of deferred annuities is tax savings. Many annuities allow you to defer taxes on investment returns or contributions until you start taking monthly distributions.
Considerations
There are many annuity products to choose from, so you need to consider the:
- High cost and limited tax benefits of variable annuities
- Hefty commission associated with fixed annuities
- Risk of loss due to outliving your assets
- Risk of loss due to insolvency of insurer or annuity company
Advice
Financial planners and retirement planning professionals recommend purchasing annuities from more than one company to reduce the risk of loss, minimize costs, and maximize returns. Even if you choose to invest with a single financial institution, it pays to understand how annuities work. Whether you need to invest a lump sum today to create a lifetime income or need to invest for your future retirement, this information can point you in the right direction for including annuities in your retirement plan.
Etienne Kiss-Borlase 