Annuities are a common feature of retirement planning, though they may be used to manage settlement money, as well. Here are the top things you need to know now about annuities. We’ll also address a few of the common misconceptions about annuities.
What Is an Annuity?
An annuity is not an investment per se. It is a contract with an insurance company or other financial institution.
That is why they’re often able to guarantee a certain rate of return, whether they’re promising 4% annually or a variable rate with a floor of 2% with a maximum return of 6%.
The money in the annuity may be invested in the market, but it isn’t considered an investment account.
How Do Annuities Work?
How does an annuity work? With an annuity contract, you agree to give them a lump sum of money.
This might be cash you saved up or a rollover from a retirement account.
The contract includes a number of terms and conditions.
Most people pay attention to the interest rate they are promised and how often the payments are made.
However, they need to understand what they’re agreeing to, as well.
What Are Some of the Benefits of Using Annuities?
Annuities take a lot of the uncertainty out of retirement planning.
You give the investment professionals the money, and you know what you’ll get back to live on.
You don’t have to monitor the investments, readjust your portfolio, and hope you have money after a market downturn.
Annuities are considered insurance contracts. This makes them subject to state law.
Depending on the state you live in, the money in an annuity may be protected from creditors even if you go into bankruptcy.
Annuities don’t have the same contribution limits as 401Ks and IRAs. You could put a million dollars in at once or make periodic deposits over time.
And there are no mandatory withdrawals like tax-advantaged retirement accounts.
What Are Some of the Disadvantages of Annuities?
The returns may not be as good as the returns you’d see if you have the money invested in the stock market.
On the flip side, there is no risk of having less money than you need to live on because the market collapsed or the dividend-paying stocks you own had a bad year.
Annuities charge you a surrender charge if you take money out of the account.
You can be hit with an additional penalty if you take the money out before you’re 59 and a half.
The ten percent or higher surrender charge can wipe out your gains for the past year or more.
What Are Some Common Legal Issues Surrounding Annuities?
Annuities pass outside of probate. Like investment accounts, the beneficiary designation on the account takes precedence regardless of what your will says.
On the other hand, failure to update beneficiary designations on the account can create problems.
For example, if you don’t update it to name your grandchildren when their parent dies, the issue may end up in court despite your ability to otherwise remain outside of probate.
Not updating the annuity beneficiary selection from your ex-wife to your new wife can certainly hurt them.
Distributions from annuities are taxed as ordinary income.
This is generally a higher interest rate than the capital gains rate you’d pay on money out of a traditional IRS or 401K.
And you wouldn’t have to pay taxes on money from a Roth IRA, because you already paid the taxes upfront. Note that you cannot borrow against an annuity the way you could a 401K.
The distributions may be less than you expect because of the hidden fees and charges.
These fees are generally hidden from the consumer when you’re sold the annuity by a salesperson who presents themselves as an insurance agent.
You must do your research to understand what a reasonable rate of return and competitive fees would be.
sattva c says
This is rightly mentioned that Annuities is excellent tools for retirement planning. This provide the investor with regular cash flow to meet the needs in the absence of regular pay checks!!! One must choose carefully the right options!!