Annuities are incredibly popular instruments for retirement planning. There is a wide range of sizes and shapes among them, and while there are positives to having a greater selection to choose from, it can also be very perplexing.
Fixed annuities are extensively preferred due to the ease in obtaining a steady source of income without worrying about complicated and high-priced products. Even so, buying an annuity is a major decision. To help you weight both sides, here are 10 fixed annuity pros and cons:
Fixed Annuity
Pros
1. Guaranteed Returns
Fixed annuities ensure that you receive a regular, predetermined dividend rate, similar to the yield from a certificate of deposit; therefore, you can be sure of the return on your investment. If you’re worried about the potential danger of investing in the stock market as you close in on retirement, this can be very helpful.
2. Guaranteed Income
Fixed annuities are probably the most sought-after option. By giving a lump sum amount to an insurance firm with a fixed annuity, you will receive regular payments from them for the remainder of your life.
Your earnings do not change depending on stock prices, the rate of interest, or the occupancy rate of your rental property. It’s guaranteed and reliable.
The insurance company could be unable to provide this income if they ceased operations. Many are doubtful of monetary corporations, yet insurance businesses are quite unlikely to fail.
The states in which they operate control them and require them to have a considerable amount of money available to fulfill their obligations, which is a lot more than what banks must assemble as reserves.
Although FDIC does not back fixed annuities, it is highly unlikely that you will not get the retirement income you were promised.
3. Low Investment Minimums
The advantage of fixed annuities is that they require a small amount of money to invest.
In the past, an insurance company may have required a minimum financial commitment of up to $50,000 before they would provide a higher end policy. These days the bar is lower. $1,000 is usually plenty to get started with.
4. Flexible Payout Options
- Timing. You can draw income from an annuity now or at any point in the future. For example, many people incorporate longevity annuities into their retirement strategies. With a longevity annuity, you might contribute $100,000 to a fixed annuity on the day you retire, with the expectation that you won’t draw income from it until you’re 85 or 90 years old. This set up is also known as longevity insurance since you create an income safety net in case you live longer than you think you expect.
- Length. You may have heard the term “period certain” in your research. When you begin drawing income from a fixed annuity, you’ll have a few withdrawal choices to pick from. The amount of income you receive is based on which option you choose:
- Straight life: consistent payments each month for the rest of your life.
- Joint life: consistent income payments each month for the rest of you AND your spouse’s lives.
- Lump sum: you can always withdraw your investment in a lump sum if you choose. If you’re considering this option, be sure you’re not incurring surrender charges or a 10% early withdrawal penalty.
- Period Guarantees. Opting for the straight life payout option can be a risky proposition. If you die immediately afterward, your family will have lost the entire amount you put into the annuity. To guard against this possibility, insurance companies offer “period certain” payout scenarios. By electing straight or joint life annuity payouts with period certain, your beneficiaries will receive your income payments if you die within a given time frame. Usually this option is offered over 10 or 20 year increments.
5. Tax-Deferred Contributions
Many annuities let you make tax-deferred contributions. No taxes must be paid on the money placed into a tax-deferred annuity until after retirement. Taxes aren’t due until you start receiving annuity payouts.
Therefore, if you don’t withdraw from your annuity, you won’t have to pay taxes on the capital gains you’re earning. You can begin receiving payments from a tax-deferred annuity one year after you’ve established it.
6. Contribution Limits
In contrast with a 401(k) or an IRA, there are no yearly contribution maximums for an annuity. You can invest any amount of money into an annuity.
7. Protection Against Market Ups And Downs
Lamar Brabham, CEO of Noel Taylor Agency located in North Myrtle Beach, South Carolina, states that annuities, particularly fixed annuities, safeguard the amount initially invested. Brabham states that the sum of an annuity will never diminish – it will stay the same or rise over time.
The idea of ‘zero being a hero’ for investors can be traced back to occasions when financial markets are doing poorly, and a lot of people have been losing money. In situations such as this, investors with annuities are given a ‘zero’ rate of interest, which allows them to hang onto their original investments and any previously earned growth, explains Brabham.
This benefit may bring solace during a difficult market situation. Under the existing circumstances, where the financial markets range from erratic to hugely negative, a large number of investors are now more concerned with recovering their investments as opposed to earning money from it.
8. Death Benefits
Beneficiaries of certain annuities can receive either a one-time payment or a portion of the regular annuity payments upon the death of the annuitant.
Although there may not be a lot of money in the death benefit, or there may not be a death benefit at all. The death benefit can be increased at an extra cost for someone who is a holder of an annuity.
Cons
1. Limited Returns and Teaser Rates
Though a fixed annuity will ensure a set rate of return, the yield is typically very low. It is often easy to generate better returns when constructing a portfolio of secure bonds.
Many insurance companies will offer low introductory rates on fixed annuities.
This implies that these investments come with a guarantee of an alluring income for a brief length of time, but then it will be decreased later on in the period. After that, you would have to endure the same small profit unless you cancelled the agreement.
Regardless, fixed annuities do not provide an opportunity for investment growth.
2. Fees, Commissions, and More Fees
Every annuity has expenses that reduce the overall return you receive. Of all kinds of annuity policies, fixed annuities regularly cost far less than more intricate versions (index and variable annuities). Here are the fee’s you’ll encounter:
A penalty will usually be included in policies that are surrendered. If you cancel the policy during a specific time period, the insurer will be charged a penalty. The longer you continue, the smaller the surrender charges will be.
The cost of annuities includes mortality and expense charges, as well as administration fees. With fixed annuities, these expenses are normally already included in the interest rate you get on the amount of money you have in the account. If a policy provides you with 4% earnings but has a fee of 1% each year, your overall returns will be 3% annually.
Commissions: Finally, annuities are normally sold as commission products. An advisor or insurance rep who proposes a product could earn a fee if you decide to purchase it.
The commission isn’t taken out of your initial account balance, instead the insurance company will cover it, but this business relationship should still be taken into account. Some professionals may be trustworthy and genuinely want to lend a hand, yet others may take whatever steps are needed to earn their commission.
3. Loss of Flexibility
It is necessary to mention financial flexibility when compiling a list of advantages and disadvantages of fixed annuities. Every annuity has an accreting phase and a disbursement phase.
The accumulation period begins when you purchase the policy. If you decide to start taking money out of your account, the period of its growth will close, and the time of you withdrawing funds will begin. This will take place while your balance increases as stated in the rate of interest.
In the period of build-up, you have some room to manoeuvre with the policy. In the case of a crisis, you can give up the policy and take out the amount of money that is left.
It is possible that you may have to pay surrender charges or penalties if you withdraw money early. These charges can sometimes be bypassed if you switch to a different plan in the 1035 exchange. If necessary, you are able to break the agreement and recover most of the money.
Once you commence the phase of taking away, you no longer have the same room for manoeuvre.
The insurance company will provide a monthly income for you, however in the event of an urgent situation you are not able to cash in the policy. The insurance company owns your principal investment. You only own the income stream.
4. Limited Inflation Protection
Once you start taking money out of your standard fixed annuity, you will be given a consistent sum of money each month. Retirees face the issue that their daily expenses will gradually increase as a result of inflation. Throughout more than three decades of retirement, this will amount to a large sum.
For instance, an annuity that gives you $1000 per month may not be enough if inflation rises 2% annually during your golden years. In 30 years, the value of your monthly annuity payments will be equal to $552.07 in present-day currency.
Keep in mind that annuities are available in many forms. There is an abundance of goods and services available at this point that afford protection against inflation, meaning your regular income will rise as inflation does.
The downside is that providing protection from inflation is usually expensive.
An annuity with inflation protection may provide a lower amount of money each month initially; for example, if an ordinary fixed annuity pays $1000 each month throughout retirement, the same fixed annuity with inflation protection could start by paying out only $750. Thus, fixed annuities have somewhat limited inflation protection.
5. Costly Riders
In many instances, some of the most attractive advantages that come with an annuity are additional features, often referred to as riders. You could end up spending more money to obtain additions such as a guaranteed minimum income or perpetual payments.
In addition to expenses like fees and commissions, a rider might further reduce your return on investment.
6. Tied-Up Money
Ron Tallou, the originator and proprietor of Tallou Financial Services located in Troy, Michigan, has pointed out that annuities may limit one’s access to their funds.
Most annuities let an individual withdraw a certain amount of their money each year without having to pay a penalty fee, usually 10% each year, throughout the withdrawal period (usually six to eight years).
If you withdraw the money before the age of 59½, you could be subject to taxation on regular income as well as a 10% federal tax penalty.
Additionally, it might not be possible to receive money back on an annuity that offers a guaranteed income for the rest of your life. Essentially, if you acquire this type of annuity, you cannot withdraw the entirety of your funds in one go.
7. Scams
Some buyers of annuities are susceptible to annuity scams. One common annuity scam targets older people. In this fraud, a representative promotes the advantages of an annuity to a senior person without informing them of the downsides like the costs and commissions associated with it.
The elderly person puts their life savings into a contract that promises to pay back a benefit in the future. The Center for Life Insurance Disputes, a company that offers life insurance grievances handling for those who pay for their services, explained that the representative receives a generous commission.
8. Fluctuating Returns
The cash value of a variable annuity will fluctuate depending on market performance. This could cause a lack of assurance as to your financial stability during retirement.
A variable annuity usually invests in mutual funds which contain assets like stocks, bonds, and money market securities like treasury bills. Hence, the yield from a variable annuity is not constant.
Who Can Benefit From Annuities
Annuities aren’t for everyone. Experts suggest that these may be a beneficial option for those close to retirement or already retired, since they provide consistent income that can supplement missing salary.
Brabham states that annuities are often used to produce a reliable, pension-like income throughout the lifetime of the annuitant, while also ensuring a surviving spouse will get a lifetime income. Once someone has gotten to a certain age, preserving the value of their savings is very important, so many people opt to invest in annuities. It is important to aim for security, progress, and cash flow and annuities may be the solution.
Ron Tallou, head and proprietor of Tallou Financial Services in Troy, Michigan, indicates that it is useful to take a closer look at specifics like payouts and structures in order to decide if an annuity is the right choice.
Tallou suggests that anyone considering getting an annuity should ask plenty of questions about the various types as there are many different ways an annuity can be set up.
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