Annuities have long been a misunderstood financial product. The widespread misconception is that annuities are only for the elderly looking to supplement their pensions. However, that is not the case at all. In fact, the younger generation is flocking to annuities as a way to prepare for retirement. This comes as no surprise, considering annuities fit the needs of the millennial generation as it does for the needs of older people. They are frugal and value their time, which is why annuities as a retirement savings vehicle have become so popular with this generation. We’ll take a look at the annuity, what they are, and why they are such an attractive retirement savings vehicle for the millennial generation.
What is an Annuity?
An annuity is a contract by an insurance company that promises to pay a specific amount of money back to you, the annuitant, at a specified date in the future or starting immediately. Usually, the contract term is for a lifetime between you and an insurance company. However, in some cases, the contract term is for a fixed number of years or a set number of years after the annuitant’s death. The contract may also guarantee a minimum return on your investment.
Why Invest in an Annuity?
The term annuity originated in the insurance industry, but it is commonly used to describe a retirement savings plan, too. The most important reason people invest in annuities is to receive periodic payments for an agreed period of time. The other reason is to reduce their taxes. Annuities are a great way to reduce your taxable income by deferring the interest you earn on your investments. They also carry death benefits. The nominated policy beneficiary will be paid in event of the death of the annuitant
Stages of Annuity Planning
There are two stages in an annuity contract.
Accumulation stage
The period where you save and potentially grow your retirement funds around an annuity and build up its cash value. It is important to start saving early in life to get the most benefits when you retire. Some people opt to deposit the lump sum amount upfront.
Distribution stage
Distribution starts when the accumulation state ends. This is when you plan to start spending money on it to create an income or cash flow for retirement. Your decision will depend heavily on the type of annuity you purchase.
What are the 4 types of annuities?
The type of annuity is determined by two factors. When you start receiving payments and how the annuity investment will grow.
Immediate Fixed Annuity
This is the most common type of annuity contract. With this type of contract, the contract holder is guaranteed a set amount of income starting immediately. The payments can come in monthly, quarterly, or annually. Annuitants that live long benefit from this plan. But those who die soon after buying the plan don’t get value for their money.
Immediate Variable Annuity
Under Immediate Variable Annuities, the annuitant pays a lump buys the plan and immediately starts receiving monthly payments. Payments received are variable, meaning they may go up or down depending on the performance of your investment. Variable annuities are designed to provide income that rises or drops, keeping pace with inflation.
Differed Fixed Annuities
Unlike Fixed Annuity where payments start coming immediately, differed annuity contract promises to differ the payments to an agreed time in the future. However, the payments will be fixed amounts.
Differed Variable Annuities
Under differed variable annuities, the annuitant pays a lump buys the plan but will start receiving payments during a differed period in the future. Payments received are variable, meaning they may go up or down depending on the performance of your investment. Variable annuities are designed to provide income that rises keeping pace with inflation. Usually, people with a higher risk appetite will appreciate this option.
How do you calculate annuity returns?
Calculating annuity is now simplified by the use of numerous calculators out there. Some of them are listed below
There are also apps that perform this function very well.
Fixed Annuities vs Variable Annuities Portfolio Investment
Fixed Annuities:
With a fixed-rate annuity, the contract holder is guaranteed an amount of income for the duration of their contract. The insurance company usually invests the funds in low-risk financial instruments, such as US Treasury securities and selected corporate bonds, with the aim of earning fixed incomes. People with low-risk appetites love this option.
Variable Annuities:
Variable annuities (also considered to be securities), whether immediate or differed, promises to make certain sums of money in the future. However, the amounts are not fixed but keep changing. The insurance company invests the funds in government bonds, money markets, corporate bonds, and stocks. Obviously, the performance of these investment instrument options will differ, making the return uncertain. This causes the returns to vary from year to year.
Pros of Investing in an Annuity
– Tax-Free Income: The best thing about annuities is that they are tax-free differed. This means that annuities will allow your investment to grow tax-free until funds are withdrawn. The amount of tax will depend on whether you bought the annuity with post-tax funds or otherwise. Consult a financial advisor before investing.
– Diversification: Another great thing about annuities is that they provide a degree of diversification. You won’t have all your eggs in one basket by putting your money in your retirement account. You’ll have some money locked in a safe investment that provides a certain amount of income.
– Affordable: Annuities are usually affordable. This is because the contract is usually guaranteed for a certain period of time, such as 30 years or longer. You can also choose a plan that fits your pocket.
– Flexibility: Annuities offer flexibility because you can buy a contract that guarantees a fixed amount of income for a period of time or a variable contract that guarantees a fixed rate of income plus a set number of years of guaranteed return.
– Time-Consuming Investment: One of the reasons why people and millennials are choosing annuities over other retirement savings vehicles is that they are a time-consuming investment. You have to put your money in an annuity, and you have to stay on top of your investments.
Cons of Investing in an Annuity
– Not East to Use: One of the cons of annuities is that they are not easy to use. You have to invest your money and keep track of your investments. This is not easy to do on your own.
– Expense of Maintenance: Another con of annuities is that they generally come with an expense of maintenance. This is because insurance companies are required to pay a portion of your annuity every month.
– No Stabilization: Another con of annuities is that they have no stabilization. This means that your payments can go up or down depending on the rate that the insurance company receives for the contract.
Choosing the right annuity for you
Below are some questions that you will need to ask yourself before purchasing an annuity
- How much money do I need during retirement each month?
- Do I have any other income apart from annuity income?
- When do I need the payouts? Immediately? Or, can I wait for a few years?
- Do I need fixed amounts?
- Can I take a little more risk and buy an Indexed Annuity?
What to ask your financial advisors
- Is it a single premium or multiple premium plans?
- What are the withdrawal, surrender, and other fees applicable?
- Is it possible to make a part withdrawal without a fee?
- What happens if the insurance company becomes insolvent?
- Can you use the policy as collateral to borrow?
Read about the Biggest Threat to Retirement Plans.
Final Words
An annuity is a contract that promises to pay a specific amount of money back to you, the annuitant, at a specified date in the future. Usually, the contract term is for a lifetime. However, in some cases, the contract term is for a fixed number of years or a set number of years after the annuitant’s death. The contract may also guarantee a minimum return on your investment. An annuity is a long-term contract that guarantees a set amount of income for the whole contract period.
Variable annuities are different in that the payments are not fixed. The value of payments keeps changing depending on the returns from the investments by the insurance company. Payments can start coming immediately, or they can be differed to start in a future agreed period. The rate of return is determined by an insurance company or a financial institution. The main difference between a fixed and a variable rate annuity is the rate of the return on your investment.
If you’re looking to build up your savings for the future, and you’ve probably been hearing a lot about annuities and their tax benefits, this article has helped explain the benefits of this product. After reading this article, you’ll be better equipped to understand Annuities. Before purchasing an annuity, book an appointment with a financial advisor to make the right decision.
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