What You Should Know About Annuity

The term “annuity” refers to an insurance contract issued and distributed by financial institutions with the intention of paying out invested funds in a fixed income stream in the future. They are designed to provide a steady cash flow for people during their retirement years and to alleviate the fears of outliving their assets. Since these assets may not be enough to sustain their standard of living, some investors may turn to an insurance company or other financial institution to purchase an annuity contract and as such, these financial products are appropriate for investors, who are referred to as annuitants, who want stable and guaranteed retirement income.

There are often two phases of an annuity

The accumulation phase; the period of time when an annuity is being funded and before payouts begin. Any money invested in the annuity grows on a tax-deferred basis during this stage.

The income distribution phase; which kicks in once payments commence

Types of Annuities

Annuities come in three main varieties: Fixed, variable, indexed and each type has its own level of risk and payout potential. For any of these, it is often structured as a deferred annuity.

Variable

Variable annuities provide an opportunity for a potentially higher return, accompanied by greater risk and in this case, you pick from a menu of mutual funds that go into your personal “sub-account.” Here, your payments in retirement are based on the performance of investments in your sub-account.

Indexed

Indexed annuities fall somewhere in between when it comes to risk and potential reward. You receive a guaranteed minimum payout, although a portion of your return is tied to the performance of a market index.

Despite their potential for greater earnings, variable and indexed annuities are often criticized for their relative complexity and their fees. Many annuitants, for example, have to pay steep surrender charges if they need to withdraw their money within the first few years of the contract.

There are very good reasons why you should purchase an annuity and they include:

If you are close to retirement age, buying an annuity can help you feel a sense of security by providing a guaranteed income during your retirement years.

An annuity would not take care of every financial retirement issue you will face and they are not a perfect fit for everyone, but they can go a long way toward making the financial side of retirement less challenging.

As much as there are benefits attached to purchasing annuity, there are also disadvantages attached to it and they include:

If a policy owner (annuitant) chooses to annuitize their annuity at retirement and start receiving payments, there is no turning the stream of income off and this is a huge disadvantage.

There is limited liquidity in most cases, meaning, while you are growing your retirement account, you may only have access to 10% of the contract value each year until the contract is expired.

In conclusion, annuities are intended as income-generating products and are therefore, best suited for individuals who want to add retirement income later on or who wish to convert a large lump sum into a guaranteed stream of cash flows over time. It may help you achieve a greater level of income stability, so that no matter how long you live, you won’t outlive that stream of income.