Annuities
What Is An Annuity?
An Annuity is a financial product that pays a fixed stream of payments to an individual. Think lottery winnings paid out over a period of time, it is considered an annuity. Annuities are primarily used as an income stream for retirees or as a way to distribute inheritance monies to your beneficiary(ies) to ensure the funds are not spent too quickly. Annuities help protect and reduce the risk of outliving their savings.
Annuities are considered an insurance product because they’re contract-issued and distributed by financial institutions such as insurance and investment companies. Upon annuitization, the holding institution will issue a stream of payments at a later point in time.
When an annuity is funded and before payout distribution begins, the funding time is called the accumulation phase. Once payments start, the contract is in the annuitization phase.
Why an Annuity?
As mentioned above, annuities are primarily used to reduce the risk of running out of money, specifically in retirement. Annuities offer a way to ensure steady cash flow for an individual(s).
Annuities also produce a lump sum to a steady cash flow, such as settlements from a lawsuit or insurance claims.
An annuity offers another crucial purpose, to transfer risk from having retirement savings in variable retirement accounts such as a 401K or IRA, to rollover into a less risky savings vehicle. Many clients choose to go this route to ensure their money is safe from market volatility by leveraging Fixed Indexed Annuities, which you will learn more on below.
Types of Annuities
Structured annuities offer a wide variety of features and factors, such as the duration of the payments. They can also be structured so that in the annuitization phase, the payments will continue for life, including a surviving spouse if a survivorship benefit is elected. Additionally, annuities can be structured for a specific period, such as 30 years, regardless of how long the annuitant lives.
Annuity payouts can also begin immediately upon conception when depositing a lump sum or defer the payout to commence later. In these options, there may be interest crediting that allows the annuity amount to continue to grow.
Fixed vs. Variable Annuities
There are two common annuity types, fixed or variable. Fixed Annuities generally allow for regular periodic payments to the annuitant. Variable annuities allow the owner to receive more significant payouts if the underlying annuity funds continue to grow due to the investment performance. If the underlying investments' performance does poorly, the payout may be reduced and provide less stable cash flow. However, due to the variable investments' nature, the fund performance can also allow for a more substantial return and increased payouts.
In a Fixed Indexed Annuity or FIA, the annuity funds' investment can include riders and features, consisting of floors and ensuring the capital is never lower than the floor. For example, if the floor is 0% and the investments perform poorly and are negative for the year, no loss is occurred by the owner. Contract owners can benefit from the upside potential of the portfolio while enjoying the protection of guaranteed floors, ensuring the annuitant enjoys the protection of guaranteed lifetime minimum withdrawals and payments.
Are Annuities bad?
The simple answer is NO. Like all financial products, they have their place, and each person's needs are unique. Annuities can be a valuable part of one's retirement plan; however, they are complex financial vehicles that require the guidance of a financial professional that understands when, and when not to use them. Ultimately, depending on your specific goals, a qualified financial professional can ensure the Annuity is appropriately structured, giving you the best option for your situation.
One of the biggest criticisms of annuities is that they are not liquid. Access to deposits in an annuity contract is not allowed for some time, also known as a surrender period; early withdrawal of all or part of the annuitant's money will incur penalty charges. The surrender period is typically for about 10 years, and the surrender charges reduce every year. Surrender fees can start above 10% for the first year and diminish to zero over the surrender period.
Is an Annuity right for me?
Every situation is different, and everyone's goals for retirement are unique. At FIRELife, we take a holistic approach to your financial life and evaluate all scenarios and financial products depending on your specific situation. In some cases, annuities may not be suitable for you and your loved ones. We recommend that you schedule your free no-obligation Financial Strategy Session so our financial experts can review your goals and strategize the best course of action for you.
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