Is an Annuity a Good Choice?
Annuities are insurance products that guarantee an income to you for your entire life or for a set period of time. This arrangement is provided by the insurance company as part of the annuity contract. However, before you purchase an annuity, you should understand how they work to determine whether or not they are a good choice for you.
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Types
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There are two types of annuities: immediate and deferred. An immediate annuity converts existing savings to an income stream that will last for your entire life or a set number of years. A deferred annuity defers this payment until a time you specify. There are two sub-types of deferred annuities: fixed and variable. A fixed annuity pays a fixed interest rate. A variable annuity pays an interest rate based on mutual funds inside of the annuity that you invest in.
Purpose
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The purpose of an immediate annuity is to ensure that you never run out of money during the period of time that the contract is in force. The purpose of a deferred annuity is to accumulate savings for your future that can be drawn on periodically or converted to immediate annuity payments.
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Benefits
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The benefit of an immediate annuity is that you never have to worry about running out of money. The insurer manages your money for you to ensure that you receive a steady income. The benefit of a deferred annuity is that you have control and flexibility as to when you receive your annuity payments. You may defer the payments indefinitely if you choose. Annuities also defer taxes on the savings inside of the annuity. This means that your savings grow without being taxed.
Disadvantages
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The disadvantage to immediate annuities is that you cannot convert the payments back into a lump-sum savings once the payments start. The disadvantage to deferred annuities is that all deferred annuities come with a maturity date. This maturity date may be 1 year or 10 years or more. Until the contract has matured, any withdrawals are subject to a penalty beyond a limited free withdrawal provision specified in many, but not all, annuity contracts. This leaves you with restricted access to your savings.
Considerations
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Before investing in an annuity, consider that annuities are long-term contracts. Payments from annuities are meant to provide stable income, not high investment returns. Deferred annuities are long-term contracts that are not meant to be cashed in prior to retirement or traded extensively.
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