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Editor’s Note: This article first appeared on SmartAsset.com
Annuities are common financial products that provide a steady stream of income during retirement.
While you may have access to customizable features and riders, you will almost certainly have to pay high fees and may end up with less money than you would if you invested it elsewhere.
It’s worth noting that those who sell annuities frequently earn astronomically high commissions.If you’re considering an annuity as part of your retirement strategy, talk to a financial advisor.
Here’s how annuities work and how to figure out if they’re a good fit for you.
What Is an Annuity and How Does It Work?
Simply put, an annuity is a financial contract between a person and an insurance company that allows the person to pay money now in exchange for a guaranteed and consistent stream of income in the future.The person who owns the annuity can pay for it all at once or in a series of installments.
An immediate annuity starts paying out right away, whereas a deferred annuity starts paying out after a certain amount of time has passed.
Depending on the needs of the individual, annuities can be structured in a variety of ways.They can pay out over the course of a lifetime or for a specific period of time.
There are two other types of annuities: fixed and variable.The rate of return for the individual investor is fixed with a fixed annuity, and it will not fluctuate throughout the life of the annuity.
Fixed annuities can also be indexed to a particular index fund or market index.
When you buy a variable annuity, the insurance company will invest your money in various funds and accounts and pay out based on the performance of those funds and accounts.
If you have a variable contract, you can also control the investments in your annuity.On the other hand, in the event of a market downturn, it can be riskier.
Is Buying an Annuity a Good Idea?
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There are a number of valid criticisms of annuities, but it’s worth noting that, depending on your financial situation and goals, there are a few potential upsides that could benefit you.
An annuity, first and foremost, ensures your income.Even if the market falls, the insurance company is obligated to pay you the amount specified in the contract, making an annuity a very secure investment.
You may not receive anything if the insurance company goes out of business.As a result, it’s critical to only work with reputable and stable insurance companies.
Another reason an annuity might be a good investment is that they frequently include customizable money management features.You can include things like minimum income benefits, which guarantee a regular payout even if the market falls.
You can also include a spousal provision, which allows payments to continue even if you pass away while your spouse is still alive.On that note, a death benefit provision allows annuity beneficiaries to receive a payment in the event of the annuitant’s death.
If you’re just looking for a way to retire on your own, an annuity isn’t the best option.However, in some cases, it could be an excellent addition to your overall retirement strategy.
If you’ve exhausted all of your other retirement account options, an annuity may be a viable alternative.If you come into a large sum of money, an annuity may be a good idea.
In this case, an annuity can help you avoid the temptation to spend it all at once.In this case, an annuity that pays out over a set number of years might be a good option.
Why Annuities Aren’t Always a Good Investment
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Annuities are frequently the target of harsh criticism.This is primarily due to the fact that, when compared to relatively simple investment strategies, they can provide subpar returns.
Those who plan to finance their retirement with a deferred annuity will almost certainly be better off first investing in an individual retirement account (IRA) or a 401(k).
These other retirement accounts offer comparable, if not superior, returns and do not charge the same fees.
One of the most significant disadvantages of annuities is that they have high fees when compared to similar products.While insurance company fees vary, you will almost always pay more than you would if you invested in funds.
In most cases, you’ll also have to pay for maintenance and operational costs.This obviously raises the price and reduces the amount of money you have in your pocket.
Furthermore, financial advisers and brokers earn higher commissions than other types of retirement accounts.In fact, they are frequently in the 7% range.
As a result, it’s understandable why salespeople would recommend annuities to clients as a source of retirement income.
Owners of annuities may be subject to surrender charges.These occur when they need to take money out of the annuity before a certain number of years have passed.
You may also be charged a 10% early withdrawal penalty because annuities are tax-deferred.However, these disadvantages may apply to other types of retirement accounts as well.
Annuities are a contentious subject.However, whether or not one is a good investment for a specific person is determined by a number of factors.These factors include your age, current retirement savings, future goals, and more.
Because of their fees and relative inferiority to other retirement accounts, annuities do have some disadvantages.You may, however, decide that an annuity is a good investment for you.
An annuity can be a good idea if you’ve already maxed out your other retirement accounts or want to distribute a lump sum over a longer period of time.You might be better off looking for retirement investments elsewhere if that is the case.
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