Shopping for annuities can be overwhelming. With so many different types of annuities to choose from, you may not even know where to start. Despite their complexity, having several types of annuities to select from gives you the ability to choose the retirement annuity that is most suitable for your long-term retirement goals. In this article, we discuss the main differences between immediate and deferred annuities, as well as three types of annuities those categories can be broken down into. Hopefully, this information will help you plan out a retirement portfolio that best addresses your long-term needs! Keep reading to learn more.
First of All, What Is An Annuity?
To truly understand annuities, you must know that there is a risk you may outlive your retirement savings. This is referred to as the longevity risk, which can be roughly estimated by average life expectancy and how much retirement savings you have accumulated. An annuity can help address this risk. By its most basic definition, an annuity is an insurance product issued by a financial institution, that provides a steady stream of retirement income to help reduce the risk of potentially outliving your retirement savings.
How Annuities Work
An annuity is purchased from a financial institution through a series of monthly premiums or lump-sum payments. The agreement is legally bound by an annuity contract that specifically defines who receives the annuity payments (the annuitant), when the payments begin being disbursed, and how long the disbursement period will take place.
Important Things to Note
There are many different types of annuity products. Depending on the annuity you purchase, you will be subject to different terms and conditions. For example, many annuities have surrender charges and penalty fees for taking out payments before the previously agreed upon withdrawal period. Some issuing institutions may also charge you for withdrawing before you reach the official age of retirement. It is also important to know that some types of annuities are subject to market risk and can lose some of their value.
There are two main types of annuities – immediate and deferred. The main distinction between the two is the payout schedule.
Immediate Annuities – Payments can be received immediately after the annuity product is purchased. However, the annuitant can choose to start receiving payouts up to a year after the product has been purchased. Immediate annuities are typically purchased with one lump-sum payment. This type of annuity is best suited for people nearing the age of retirement, who would like to begin receiving payments within a year of purchasing the annuity.
Deferred Annuities – Deferred annuity payments are, as their name implies, delayed until a specified date has been reached. Because the payments are delayed, the money you have invested will have more time to grow, potentially offering larger returns during the payout period.
Within immediate and deferred annuities lie several types of annuities. Both immediate and deferred annuities can be fixed, variable, or indexed. The amount of risk differs depending on the type of annuity you purchase, potentially affecting the size of your payouts.
Fixed annuities are arguably the safest annuity product, due to being relatively low-risk. They typically have the lowest fees and are known for being the most predictable. While the money invested in a fixed annuity can still accrue interest, its payments are the most reliable of all product types. Fixed annuities are best for individuals who prefer stability and security over the potential of higher returns due to riskier investments.
Variable annuities are considered to be a bigger risk than fixed annuities but can produce bigger returns. With a variable annuity, you can choose from multiple investment options, usually stocks, bonds, and/or money market instruments. As a result, your returns can fluctuate based on how well those investments perform. Variable annuities work on a tax-deferred basis, meaning you won’t have to pay taxes until you start making withdrawals, and some contracts have insurance features like the option to assign a beneficiary, promised annuity value, and unlimited withdrawals.
Indexed annuities, previously called “equity-indexed annuities,” have qualities from both fixed and variable annuities. They offer both a guaranteed interest rate and an interest rate linked to the market index. Because the annuitant can choose which market index to base their interest rate on, indexed annuities are less risky than variable annuities, but can produce higher returns than fixed annuities can.
Which Annuity Type is Right For Me?
Which annuity type is right for you depends on a wide variety of factors. To start, when you picture your retirement, what concerns come to mind? Addressing those concerns will help you choose the right annuity for your retirement goals. Otherwise, other questions to ask yourself include:
- How soon do I want to begin receiving payments?
- How much risk am I willing to take?
- How much money am I investing up-front?
It’s also important to consider where you are in your life. Are you nearing retirement or are you at the official retirement age? If you have more time before you officially retire, consider purchasing an annuity that can produce a higher return at a higher risk. If you need a stream of guaranteed retirement income as soon as possible, consider investing in a relatively lower-risk annuity that can provide stable returns.
The world of annuities is complex and can be rather confusing. Just the word “annuity” alone tends to turn many people off and for a decent reason, as there are many annuity salesmen who are just trying to grind your retirement income into their commission. However, there are many annuity contracts out there that can really fill in the gaps in your retirement portfolio, but it’s a matter of finding the right one that best suits your retirement goals. Taking an honest look at your lifestyle and where you want to be when you retire will help you make all difficult decisions involving your retirement.