An annuity can be an important and productive part of your investment portfolio. It is an insurance product that is part of a retirement strategy to augment other sources of retirement income. On the other hand, an annuity is an investment that requires a large upfront payment and often a willingness to cloister the funds for years until you retire.
Is an annuity a good approach for your portfolio? Read on to find out.
Your Options
You can buy an annuity plan that starts paying out immediately or at some defined point in the future. The latter, which is known as a deferred annuity, cost less because the seller can hold on to your cash for a fixed period of time before paying you back.
Then, there are the fixed versus variable annuities. Fixed annuities come with fixed interest rates or payouts. They generate a predictable income, and neither increase nor decrease if interest rates change. Variable annuities, as the name implies, tie the payout to the performance of the stock market or some other group of securities in the seller’s portfolio.
The Advantages
The main advantage of buying an annuity is that you can stash additional (excess or windfall) money to set aside for retirement. You must be willing to sock away the funds for years to avoid hefty surrender fees.
So, if you have the money and can give your annuity account time to grow, you will accrue its main advantages. That money put away for those sunny days of retirement, unlike an IRA, has no annual contribution limit. The interest compounds year after year without tax liability, which can be a significant advantage over taxable interest and investment income.
When you are ready to cash out, you can opt for a lump-sum payment or set up guaranteed monthly payments for a specific length of time to augment your other retirement income sources. If one of your sources is a monthly retirement benefit that stops or decreases if you die before your spouse, the annuity proceeds ensure a continued income for your beneficiary.
Potential Problems
Annuities are a lock on the funds you invest. With a bank account or stock, you can access your funds or sell shares to free up the cash for that time-sensitive investment opportunity. Try to withdraw funds from an annuity account, and you could be facing a surrender fee of up to 20 percent.
An annuity, like any other insurance policy, is a wager that you will live long enough to cash in on its benefits. It is the reverse mortgage of insurance policies with a twist, however: You give the seller a large sum of money, allow them to hold onto it and invest and grow the money you cannot spend yet. If you don’t live long enough to cash out, you are not around to collect on your investment.
In the meantime, your insurance company may erode your returns by charging commissions as high as 10 percent at the outset, and annual fees over the life of the annuity. If you purchase a variable annuity, for example, the insurance company could charge you an annual rate of 1.25 percent along with additional management fees amounting to 2 to 3 percent a year or more.
How to Make Your Decision
You have weighed the pros and cons of purchasing an annuity. You are past 40 and have decided to shore up your retirement income so as not to have more life left at the end of your money. You have the cash and are ready to seriously consider buying an annuity.
If an annuity fits into your plans, narrow your choices. Calculate your monthly payouts based on the amount of money you plan to invest. Purchase your annuity from a highly rated insurance company.
Next, add up annuity account expenses, including commission and early surrender fees. Check out variable annuities offered by companies like T. Rowe Price, Fidelity, and Vanguard, who typically charge around 2 percent.
An annuity can be a tax shelter, but the money it protects is not available for more agile investment planning. Shop around and see if other non-annuity investments could yield better long-term results. If you have an IRA, resist the temptation to roll it into an annuity and possibly lose 3 percent on top of the commission the seller rakes off the top of its value.
Regards,
Ethan Warrick
Editor
Wealth Authority
