Annuities

Annuities can be optimized for income or long-term growth, but they are not short-term investment strategies. These products appeal to people whose objectives include long-term financial security, retirement income, diversification and principal preservation.

An annuity is an insurance product designed to provide consumers with guaranteed income for life.

More specifically, an annuity contract is a legally binding, written agreement between you and the insurance company that issues the contract. This contract transfers your longevity risk — the risk of you outliving your savings — to the insurance company. In exchange, you pay premiums as outlined in the contract.

Annuities work by converting a lump-sum premium into a stream of income that a person can’t outlive. Many retirees need more than Social Security and investment savings to provide for their daily needs.

Annuities are designed to supply this income through a process of accumulation and annuitization or, in the case of immediate annuities, lifetime payments guaranteed by the insurance company that begin within a month of purchase — no accumulation phase necessary.

In essence, when you buy a deferred annuity, you pay a premium to the insurance company. That initial investment will grow tax-deferred throughout the accumulation phase, typically anywhere from ten to 30 years, based on the terms of your contract. Once the annuitization, or distribution, phase begins — again, based on the terms of your contract — you will start receiving regular payments.

Annuity contracts transfer all the risk of a down market to the insurance company. This means you, the annuity owner, are protected from market risk and longevity risk, that is, the risk of outliving your money.

To offset this risk, insurance companies charge fees for investment management, contract riders, and other administrative services. In addition, most annuity contracts include surrender periods during which the contract holder cannot withdraw money from the annuity without incurring a surrender charge.

Furthermore, insurance companies generally impose caps, spreads and participation rates on indexed annuities, each of which can reduce your return.

Annuities come in two basic configurations: immediate or deferred.

The option you select will depend on your financial goals. If you want to begin receiving annuity payments right away, you will choose an immediate annuity.

Alternately, if you would like to set your payments to begin at some point in the future, you will purchase a deferred annuity and specify the start date in your contract.

Different types of annuities exist to fit the diverse needs of the market. Your personal goals and objectives will determine the type of annuity that is right for you.

People buy annuities to create long-term income. While most often considered financial solutions for older people who are close to retirement, annuities can benefit investors of any age with a variety of financial goals.

Immediate annuities are generally suitable for people who are within a year of retirement and want the security of guaranteed income. Remember, single premium immediate annuities (SPIAs) begin paying out within a year of purchase. This means there is no accumulation period as there is with deferred annuities.

For this reason, SPIAs are also beneficial for younger people who have inherited a large sum of money and wish to protect the windfall from poor financial management.

In contrast, deferred annuities are generally not recommended for people who have short-term financial needs or younger people with more aggressive investment strategies.

One of the key benefits of an annuity is that it allows the investor to save money without paying taxes on the interest until a later date. Annuities have no contribution limits, unlike 401(k)s and IRAs.

Another significant benefit of annuities is the creation of a predictable income stream to fund retirement. With an annuity, you don’t have to worry about outliving your savings. This is a major advantage in the post-pension age.

Your reasons for investing in an annuity should align with your unique lifestyle and financial situation.

Some consumers see sacrificing liquidity in return for lifetime financial security as a disadvantage. Indeed, if your financial status or short-term goals limit the amount of cash you have on hand, an annuity is probably not the right solution for you. It wouldn’t make financial sense to purchase a valuable, viable product if it’s not valuable and viable for you.

The loss of potential returns is what’s known as “opportunity cost.” People frequently cite opportunity cost as drawback. This objection is valid for people with higher risk tolerance. For example, younger investors with longer time horizons would most likely benefit from a more aggressive investment strategy because they have time for their money to grow and could bounce back from temporary market losses.

Older investors and retirees, on the other hand, need to assess opportunity costs as they relate to their specific circumstances. It is less likely that people in this age group would consider opportunity costs a disadvantage of an annuity.

For many investors, the main objection to annuities is the risk of losing access to their money for the length of their contract. This means that in addition to the possibility that you won’t be able to cover unexpected expenses, you may miss the opportunity to take advantage of higher interest rates or to invest in the stock market.

This is where your understanding of your long-term goals comes in. Your decision to purchase — or sell — an annuity should be in alignment with your goals, and you should be comfortable with having your money locked down for a modest payout in exchange for guaranteed lifetime income.

To reduce your opportunity cost, consider a partial investment upfront. This will allow you to reserve some of your savings for unplanned expenses and give you the ability to capitalize on a potential rise in interest rates.

Getting started is as easy as contacting us now. We’ll put you in touch with our partner, Senior Market Sales, for more information on securing your financial future.