What is an annuity:
An annuity is an insurance product that works as an investment tool by paying out a fixed amount of money over a certain time-period. Deciding on what type of annuity, how much to invest, and the best time to add an annuity to your portfolio mix can be a perplexing process. There is a general lack of knowledge about what annuities are because they don’t get the same kind of marketing as other investment products, like a 401(k) or life insurance. Understanding which one is right for you requires a bit of homework on the investor’s part, as well as working with a qualified agent who can help streamline the process.
Common types of annuities:
Fixed: These provide a guaranteed return and have nothing to do with the stock market. So, there is not a stock market risk with a fixed annuity, which means you will receive a specific return or more on your money.
Variable: These are opposite of a fixed annuity as the interest rate fluctuates because they correlate with the stock market. Because variable annuities involve risk, there is a potential to lose money.
How do they work:
You would contribute to the annuity either with a lump sum or through payments. The money is invested by the annuity provider and grows over time by earning interest.
Why an annuity:
Annuities provide income. People who want to ensure cash flow during retirement may use an annuity to guarantee a set amount of money each month. Annuities can also pass along directly from the insurance company to the beneficiaries, therefore avoiding the probate process.
Contribution amounts:
Depending on the insurance company providing the annuity product, minimum contributions can be as low as $2,500, and maximum contributions are usually set at $2 million.
Differences between an annuity and a life insurance policy:
Typically, a person would buy a life insurance policy to provide a tax-free lump sum benefit for a beneficiary upon the policy holder’s death. An annuity can provide income to the investor during their lifetime, typically to help with retirement.
When to purchase an annuity:
There is no federal law or rule that sets a minimum or maximum age limit for annuity purchases but insurance companies that sell annuities set their own age limits. Some companies will not let anyone under 18 purchase an annuity, while the upper age limit is typically between 75-95.
Selecting an annuity is often based on your financial situation and your investment goals. If you are looking for a safe, steady growth investment, then a fixed annuity might be for you. If you have a higher risk tolerance, then a variable annuity could be the way you want to go.
Typically, you can access 10% of the amount of the annuity, each year, without a surrender charge. A “surrender charge” is a type of sales charge you must pay if you sell or withdraw money from a variable annuity during the “surrender period”, a set period that typically lasts six to eight years after you purchase the annuity. Surrender charges will reduce the value and the return of your investment. If you annuitize the money and create an income stream, you won’t incur a penalty.
Both qualified (funded with pre-tax dollars) and non-qualified (funded with post-tax dollars) annuities require you to be age 59 ½ before withdrawing funds. If you withdraw before 59 ½, the IRS imposes a 10% early distribution penalty. If the early distribution is from a qualified annuity, the whole distribution could be subject to the 10% penalty. In the case of a non-qualified annuity, the penalty would be imposed on the earnings portion of the distribution.
Portfolio diversification:
Fixed annuities are considered the foundation of a portfolio because they are safe and secure from market fluctuations. Once the foundation is solid, you can add to it with investments that have different risk tolerances. That’s when a variable annuity might come into play.
Choosing an annuity type:
An investor wants to make sure their goals are aligned with their particular investment strategy. Speak with a financial services agent to evaluate what makes sense. He or she will conduct a financial needs analysis which should determine what products are right for you. The options available for investment are diverse. An annuity or financial agent will direct you down the right investment path.
