What Are Annuities
Annuities can be an essential part of an effective retirement savings strategy. If you haven’t heard of annuities before, here’s how they work.
- You invest into an annuity.
- You pay into that annuity regularly.
- The annuity makes payments to you on a future date
Annuities can be set up to pay you on a monthly, quarterly, or annual basis. You can also choose to have your annuity payout in one lump sum that will be dispersed on a predetermined date. Depending on how your annuity is structured, you can receive payments for years or even for the entire remainder of your lifetime.
Types of Annuities
As stated before, an annuity is an insurance contract that is designed to pay you a regular income in the future. There are three primary types of annuities for consumers to choose from; fixed annuities, variable annuities, and indexed annuities. Each type has a different risk level and payout potential. Here’s what you need to know about each type of annuity:
Fixed Annuities
The money in a fixed annuity can only grow and will never drop in value. The rate of growth may vary though. Fixed annuities can grow at a fixed dollar rate, or based on an interest rate. In some instances, growth may be determined by a formula that is specified by your provider.
The growth of your annuity is not directly dependent on how well the various investments that support the annuity perform. Though, higher interest rates are awarded to annuities that perform more favorably than expected. An annuity that has its value determined by a specified stock index’s performance would be known as an equity-indexed annuity.
Equity indexed annuities are still fixed annuities. Therefore, they still credit a minimum rate of interest. The only difference is that equity-indexed annuities are significantly impacted by relevant stock performance.
Market-value adjusted annuities are another type of fixed annuity that offers plan members the option to select and fix the time period and interest rate within which their annuity will grow. This also doesn’t prevent them from accessing the funds when they are needed, as a market-value adjusted annuity can be withdrawn before the end of the time period that was selected. This flexibility can be achieved by adjusting the value of the annuity up or down, reflecting the change in interest rates that occurred during the selected time period.
Variable Annuities
Variable annuities are higher risk plans that offer purchasers a greater potential for higher returns. When you buy a variable annuity, you have the option to pick from a menu of mutual funds that will be included in your sub-account. The payments you receive during retirement will be based on how well the various investments in your sub-account perform.
Variable annuities function similarly to many other traditional investment vehicles, except the fund is only available to individuals who invest in the insurer’s variable life insurance or variable annuities. Luckily, many variable annuities offer buyers many different fund alternatives to choose from.
Who Should Get An Annuity?
Annuities are best for individuals who are looking for a source of guaranteed income that they can tap into during their retirement. Some finance professionals may suggest that annuities are not the best option for some retirement strategies, but they do offer some advantages. While there are alternative investment options that may have potentially higher returns, annuities are great for people who want less involvement with their retirement investments.
