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To determine whether an annuity is right for you, first evaluate your lifestyle, your needs and your risk tolerance, which is essentially your comfort with various levels of risk. Because annuities are contracts, you can customize them to suit each of these areas.
A smart annuity purchaser does his or her research before taking the plunge. You should have reviewed the reasons to buy an annuity — premium protection, lifetime income, long-term care and financial provisions for loved ones — and know what questions to ask and when to seek advice from a professional.
How Do I Buy an Annuity?
After you’ve chosen your annuity provider and decided the terms of the contract, you’re ready to buy.
But what’s the process for buying an annuity?
“I think the process is twofold,” says certified financial planner Marguerita M. Cheng. “Are you purchasing an annuity with retirement funds, such as an IRA? If that’s the case, it would be a custodial transfer and a non-taxable event. With non-retirement money, if it’s cash in your checking account, you can write a check. If it’s cash in your brokerage account, you could initiate a transfer.”
- Assess your current and future financial needs.
If necessary, enlist the help of a professional. As of 2019, the Certified Financial Planner Board of Standards Inc. requires that all certified financial planners act as fiduciaries. This means that under the new Code of Ethics and Standards of Conduct, CFPs must always act in the best interest of their clients.
You’ll find useful retirement planning questionnaires online, and your advisor should walk you through their own questions as part of their consultative approach.
- Choose your annuity product based on your objectives — income or growth, for example — and careful consideration of the contract terms.
Some annuities are accompanied by an illustration to provide full transparency to investors. The National Association of Insurance Commissioners defines an illustration as “a personalized presentation or depiction prepared for and provided to an individual consumer that includes non-guaranteed elements of an annuity contract over a period of years.”
The Securities and Exchange Commission requires annuity providers to deliver a prospectus to investors considering variable annuities. As with illustrations, the purpose of the prospectus is to ensure investors make informed decisions.
- Select your provider.
Refer to financial rating agencies, such as Moody’s and Standard & Poor’s, to get recent ratings on annuity providers. Because annuities are not backed by the federal government, it’s important that you choose a reputable, stable carrier.
- Complete the application.
Lock in your rate by submitting your application “in good order.” This simply means that the application is filled out completely and accurately. Failure to do this can prolong the processing time, which may affect whether the insurance company honors the quoted interest rate. Keep in mind, insurers’ rate lock policies differ, and not all types of annuities offer illustrations or the option of locking in your rate.
- Transfer the funds.
You can pay with cash, retirement funds, or a transfer from a brokerage account. Make sure you understand the tax implications of your payment type.
- Take advantage of the free-look period.
Most insurance companies give buyers a period of 10 to 30 days from the contract start date to reject the annuity and receive a refund. If your contract doesn’t include a free-look period, ask the agent to explain why it doesn’t.
“If you have investments you need to sell to fund the account, please consult with your tax advisor regarding the tax implications,” Cheng advises. “You don’t want to invest all the proceeds.”
When Should I Purchase an Annuity?
In short, the best time to buy an annuity is when it meets your needs. That differs from person to person, so you should have a good handle on your investment goals and the best ways to meet them.
So the first step is to look at your financial situation and goals and consider, given all that, if you should buy an annuity.
For example, if you’ve maxed out your contributions to other tax-advantaged retirement accounts and you would like to set aside more money for retirement, you might want to consider purchasing an annuity. Annuity funds are tax deferred, meaning you don’t pay taxes on any earnings until you start receiving payouts.
Interest rates also play a role in purchasing an annuity. The best time to lock in your contract is when interest rates are high. If they’re low, you may want to wait. Or you could consider laddering, a strategy that allows you to take advantage of fluctuating conditions by purchasing more than one annuity at different points in time.
The earlier you buy a deferred annuity, the more time it will have to grow. A deferred annuity is an annuity in which the payout to you begins at a point later in time, typically after retirement. The longer you put off receiving the income stream, the higher the payments will be.
"The decision to purchase an annuity is very personal."
If you’re close to retirement or are retired and looking for a way to turn your savings into a stream of income, an immediate annuity might be the right option for you.
“When you make a decision to purchase an annuity, you are giving up access, or liquidity, in exchange for guarantees,” says Cheng. “That’s the first consideration. How much of my resources am I okay with not being able to access immediately?
“Next, you can think about how soon you need the money. This involves deciding if you want a deferred or immediate annuity. Finally, do you value stability and predictability? That can help you determine if fixed or appropriate is right for you.”
How Will Purchasing an Annuity Affect My Retirement Plan?
The guaranteed income stream provided by many annuities gives retirees peace of mind by ensuring their needs will be provided for as they traverse their golden years. Employer-provided pensions are quickly becoming extinct, leaving retirees to live on Social Security and their savings.
Social Security replaces only a small amount of pre-retirement income. And determining how to spend savings to live comfortably in retirement while not depleting them entirely is a challenge because it’s impossible to know how long you will live.
Enter annuities, which provide what the industry calls “longevity insurance” by insuring against outliving your savings. A life annuity will provide periodic payments — an income stream — for your entire life, no matter how long you live, even if your initial principal and earnings have been exhausted. You can also purchase a joint annuity with your spouse so you both receive the payments for your entire lives.
Annuities can also address strategic needs in your retirement portfolio. For example, a qualified longevity annuity contract (QLAC) is purchased inside a qualified retirement account. Up to certain limits, the money used to purchase a QLAC is exempt from your required minimum distribution (RMD).
An RMD is the amount of money the IRS requires you to withdraw from your tax advantaged savings accounts every year once you hit 70½ years of age. For some people, this can be problematic, affecting taxation and Medicare costs. QLACs can effectively solve for that problem.
What Are the Advantages and Disadvantages of Buying an Annuity?
Annuities come in many different flavors, each with its own advantages and disadvantages. Typically, the simpler and more straightforward the annuity, the less expensive it is. But it’s impossible to give a definitive list of pros and cons of annuities across the board. That would be like citing the pros and cons of pizza toppings: pineapple may be a pro for one person and a significant con for another.
The one advantage to virtually every annuity is the tax treatment. Annuity premiums — insurance-industry terminology for the purchase price of your contract — grow tax-deferred until you start receiving payments.
On the other hand, most annuities have the disadvantage of locking up your principal investment for several years, unless you decide to sell your annuity payments at a discount to a company called a factoring company. This may be an option if you have an urgent need for cash.
Your best course of action is to research different types of annuities to get a full understanding of the advantages and disadvantages of each.
How Do I Choose the Best Annuity for Me?
“The decision to purchase an annuity is very personal,” says Cheng. “Every investor’s financial situation is unique.”
Determine your needs and goals, and evaluate your comfort level with risk.
Are you looking for guaranteed income or long-term growth? How close are you to retirement? What other income streams do you have in place? Are you prepared for lifestyle changes that come with retirement and the loss of a steady income?
For example, if you want a reliable income for life with little risk and low costs, you might consider a fixed annuity. If you’re comfortable with taking some risks in exchange for the possibility of higher returns, a variable annuity might suit you.
Likewise, you should consider riders, such as long-term care insurance, to customize the base contract to suit you. Do you want to provide for your loved ones after you’re gone? Then you should consider getting a rider that includes the ability to designate beneficiaries.
Because annuities — and finances in general — can be complicated, it’s important to talk to a professional who can help you evaluate your retirement portfolio and explain your financial options.
Take your time. Make sure you understand all the provisions of your annuity contract, including the fees and commissions. Get more than one quote so you can compare the offerings of different insurance companies.
Finally, confirm that the company you’re considering has a good reputation, complies with annuity regulations and is financially sound.
7 Cited Research Articles
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