Annuity Basics

Annuity Question and Answer

Q. Start with the basics. What is an Annuity? 

A. The quick answer:  An annuity is a series of payments that are typically made over many years.   The more complete answer:  An annuity is a series of payments that can start now or at some date in the future.  The payments are designed to last for a certain period of time, specified upfront, which can be either a set number of years (maybe 10, 15 or 20) or until the person receiving the payments dies.  The payments can be “fixed”, meaning every payment is the same amount, no matter what, or they can be “variable”, meaning the payments can go up, or down, based on investments you choose.

Q. Sounds like I would have some choices to make if I buy an annuity.  Can you explain?

A. These choices give you flexibility to create an annuity that meets your particular needs, and they affect how much the annuity will cost.  Some of the most important choices you’ll make are (1) when the annuity payments will start, either now or at some date in the future, (2) how long the payments will last – some annuities are designed to last for the rest of your life, no matter how long you live, while others make payments for a set number of years, and (3) whether you want the payments to be “fixed” – that’s called a Fixed Annuity, or whether the payments will be based on how certain investment funds perform – that’s called a Variable Annuity. There’s also an Indexed Annuity, where payments are linked to an equity index but include a guaranteed amount.

Q. Can you give me some examples of why people buy these annuities?

A. Imagine you’re 50 years old and expect to retire at age 65.  You decide to buy an annuity that will provide a monthly payment starting in 15 years (when you’re 65) and will continue until you die.  You want to participate in stock market returns from now until the time your annuity payments begin, so you choose a Variable Annuity.  That means the amount you will receive each month will depend on the performance of mutual funds you choose to invest in, with a minimum guaranteed payout.

Another scenario:  You’re 62 years old and are planning to retire in a few months. You’re not eligible for Medicare yet, so you’ll need to buy health insurance.  You also want to do some traveling, but you don’t want to start claiming your social security benefits until you’re 65 (or older).  You want a guaranteed amount of income to help cover those expenses, to supplement the amounts you plan to start withdrawing from your 401(k) and Roth IRA.  You’re in good health so you want that extra income to last for 20 years, until you’re 82, when you figure you’ll be done traveling and your social security benefits plus other savings will be enough.

Q. Instead of an annuity, why not just invest that money in a mutual fund?

A. People buy annuities for many reasons, but ultimately it comes down to wanting a steady source of income in retirement.  While Social Security benefits are one source of guaranteed income, few people expect it to be enough to cover their expenses, and few people have a pension these days.  Even though you may have other sources of income put away for retirement, such as a 401(k) Plan or an IRA, those accounts usually hold mutual funds or other investments that don’t generate an automatic, guaranteed payment to you every month.  Annuities do.  

Q. How do you buy an annuity?

A. Annuities are provided only by insurance companies (we’ll come back to this point, because it’s important). You can go directly to a specific insurance company for information about their annuities, or you can go through a big bank or brokerage firm, an independent agent, or an investment advisor who can provide details on annuities from a number of different providers. While you can get some information about prices online, you’ll need to talk with an actual person before you sign a contract. 

Getting back to our earlier point, that annuities are provided by insurance companies – keep in mind that you are relying on that company to make good on a promise to pay over a long period of time.  You’ll want to buy an annuity from an insurance company that is rock solid.

Q. Are annuities a good investment?

A. That depends upon how you define “good investment”!  If you are looking for a tax-deferred way to generate guaranteed income for your retirement, gives you peace of mind and balances some risks you may be taking in your brokerage and/or retirement savings accounts, an annuity can be a great investment.  If you simply want to invest in the stock market and do not think you will need a guaranteed income stream in retirement, an annuity may not be the best approach to investing for you.

Of course, there is more to know before you buy an annuity, but if it sounds like this could be a good solution for your needs, our additional resources are a good place to get more information

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