Planning for Retirement: Understanding Annuities

January 16, 2019
CambridgeEntrepreneurAcademy

Planning for Retirement: Understanding Annuities

By the time that you’re retired, you’ve hopefully saved up enough for your nest egg. However, what if you find out that your IRA or 401(k) is not enough? This might be a good time to consider supplementing your retirement savings strategy with other investments, like annuities for example.

Annuities are investment products that enable you to make extra income upon your retirement.

What Exactly are Annuities?

Annuities are financial contracts between you and an insurance provider. Generally speaking, you buy a contract for a certain amount, either through periodic or lump sum payments. In turn, the insurance provider will regularly pay you a predetermined amount. Depending on the specific kind of annuity your purchase, you might start getting payments at a later date or right away. Likewise, you could opt to receive annuity benefits payments until you pass away or for a predetermined time.

Different Kinds of Annuities

While there are a couple of different kinds of annuities you could pick from, annuities generally fall into the variable and fixed categories. With fixed annuities, you could enjoy guaranteed returns equal to what you paid for the principal, plus low-interest rates. Also, the payments you receive would stay the same for the entire contract term, which means that you’d know exactly how much you could expect to earn. Before you say yes to that insurance provider selling you fixed annuities, however, take note that some fixed annuities might be indexed, meaning that your returns would be linked to a particular market index.

With variable annuities, on the other hand, while you’re guaranteed your principal investment, the returns are not. With this kind of annuity, you can select what you want to invest in, which means that you’ll get significant if you pick a high-performing investment. But while variable annuities could offer better higher returns, they likewise come with a greater degree of risk.

An Important Note on Buying and Selling Annuities

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Banks, insurance companies, mutual fund firms, and brokerage companies sell annuities. When buying an annuity, make sure to read and understand your contract thoroughly. Keep in mind that when choosing what to invest in when buying a variable annuity, pay close attention to the mutual fund prospectus. Get prospectuses for every single mutual fund you’re considering investing in. Read all of them carefully before deciding how you’ll use your payments among all of them if you’re investing in multiple mutual funds.

It’s likewise extremely vital to note that if you’re planning on investing your money in a variable annuity via an IRA or 401(k), or another tax-advantaged retirement account, you won’t be able to obtain extra tax advantages from the annuity. In cases like these, only purchase a variable annuity if it makes financial sense due to the other features of the annuity, and not the potential tax advantages.

Ultimately, if you are searching for a tax-advantaged and predictable investment to supplement your retirement income, annuities are a viable choice. But whether annuities make financial sense for you or not, would significantly depend on your long-term goals and how much you’ve managed to save.

 

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