Broker Check

What Are Annuities?

| October 23, 2017
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What is an annuity?

 

An annuity is an investment arrangement with an insurance company who agrees to make payouts to the investor beginning at a specified date. Unlike insurance policies that make payouts only in the event of accidents or misfortune, annuities are essentially investment-backed retirement savings accounts with guaranteed payments.

 

How do annuities work?

 

An investor makes a lump sum contribution or a series of contributions and may opt to receive a single payout or a sequence of payments at a date set out in the contract. Distributions may be made monthly, quarterly, or annually, as well as in the form of a one-time total disbursement.  

 

What are the basic types of annuities?

 

Fixed, variable, and indexed are the more common types of annuities. Here’s a quick breakdown of each type:

 

Fixed annuities generate predictable income as they offer fixed interest rates and fixed payouts. Fixed annuities tend to be more stable as they are backed by high-quality investments, such as corporate and government bonds.

 

Variable annuities can potentially generate higher returns – and, therefore carry higher risk – as the policy holders have more control over and access to a wider variety of investment strategies. Unlike fixed annuities that offer guaranteed rates of return, variable annuities are tied to the market performance of an investor’s chosen portfolio containing various asset types, such as stocks, bonds, and money market funds.

 

Indexed annuities combine the advantages of fixed and variable annuities, balancing the low-risk nature of the first with the potential higher rates of return of the latter. Earnings are tied to the market performance of benchmark indexes, such as the Standard & Poor’s 500.

 

What are the benefits of annuities?

 

While each type of annuity offers different rewards, in general, annuities offer quite a few benefits, including:

 

  • No contribution limits. Unlike other retirement savings accounts, such as 401(k)s that have contribution caps ranging from $18,000 to $24,000 depending on the age of the investor, annuities allow individuals to pour as much money into these accounts as they see fit.
  • Tax-free contributions and interest. Investors do not have to pay taxes on savings or interest earned from investments until they make withdrawals. Even though taxes are paid eventually, the rate is generally lower and seniors are often afforded more deductions.
  • Guaranteed payouts. Retirees’ lifetime payments are guaranteed by the insurance agreement even in the event the value of the contract has been exhausted.

 

What are the disadvantages of annuities?

 

No contribution limits, tax-deferred status, and guaranteed payouts are wonderful perks, but there are some drawbacks of annuities investors ought to consider:

 

  • Guarantees are only as strong as the insurance companies. If a company goes belly up, so do the contracts and hopes of receiving payouts. Investors should research insurance companies to ensure they are A-rated before signing any agreements.
  • Added fees. Many annuities charge additional fees, such as administrative fees that cover the cost of managing the account and mortality and expense (M&E) fees that compensate insurance companies for their assumed risk. Annuity brokers may also be entitled to commissions.
  • Withdrawal penalties. Most annuity contracts specify a surrender charge in the event an investor wants to take out more than the amount set out in the agreement. For example, some plans allow recipients to withdraw a certain percentage of interest earnings each year. Any amount above this limit may result in a surrender charge.

 

There are many pros and cons and various types of annuities to consider when deciding on whether an annuity is right for you. If you’d like to simplify the process, please contact Ventura Retirement Income Specialists for a free consultation.

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