What is an Annuity?
An annuity is simply a contract with a financial institution or an insurance company that provides clients with a guaranteed minimum return on their investment. These tools are often compared to Certificates of Deposit commonly known in banks.
Annuities are an investment option that can provide a guaranteed income for an individual or their spouse. They are purchased for a set period of time and pay out a specific amount in retirement based on the investment strategy and amount invested. Annuities can help to alleviate the fears of outliving one’s assets.
Why an Annuity?
In a ‘bear market’, when most investment types lose value, annuities can provide stability. History teaches us that bear markets always happen; it is just a matter of time.
Investments in bonds can also provide some stability over other products, but these still typically underperform annuities. Annuities provide safe, secure compound growth and lifetime income.
These financial products can provide immediate or deferred income. Immediate annuities are often purchased by people of any age who have a large lump sum of money, such as from a savings account, a settlement, or an inheritance, and who prefer to exchange it for cash flow into the future. Deferred annuities are structured to grow on a tax-deferred basis and provide annuitants (the owner) with guaranteed income that begins on a date they specify.
Individuals who invest in annuities cannot outlive their income stream, which hedges longevity risk. So long as the purchaser understands that they are trading a liquid lump sum for a guaranteed series of cash flows, the product is appropriate. It is important to remind purchasers hoping to cash out an annuity in the future at a profit that this is not the intended use of the product.
Annuities often come with tax considerations, so it is important to understand how they work. As with any other financial product, be sure to consult with a tax professional before you purchase an annuity contract.
Annuity products are regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). Agents or brokers selling annuities need to hold a state-issued life insurance license, as well as a securities license in the case of variable annuities. These agents or brokers typically earn a commission based on the notional value of the annuity contract.
Annuities can be structured generally as either fixed or variable:
- Fixed annuities provide regular periodic payments to the annuitant.
- Variable annuities allow the owner to receive larger future payments if investments of the annuity fund do well and smaller payments if its investments do poorly, which provides for less stable cash flow than a fixed annuity but allows the annuitant to reap the benefits of strong returns from their fund's investments.
While variable annuities carry some market risk and the potential to lose principal, riders and features can be added to annuity contracts—usually for an extra cost. This allows them to function as hybrid fixed-variable annuities. Contract owners can benefit from upside portfolio potential while enjoying the protection of a guaranteed lifetime minimum withdrawal benefit if the portfolio drops in value.
Other riders may be purchased to add a death benefit to the agreement or to accelerate payouts if the annuity holder is diagnosed with a terminal illness. The cost of living rider is another common rider that will adjust the annual base cash flows for inflation based on changes in the consumer price index.
- Annuities are financial products that offer a guaranteed income stream, usually for retirees.
- The accumulation phase is the first stage of an annuity, whereby investors fund the product with either a lump sum or periodic payments.
- The annuitant begins receiving payments after the annuitization period for a fixed period or for the rest of their life.
- Annuities can be structured into different kinds of instruments, which gives investors flexibility.
- These products can be categorized into immediate and deferred annuities and may be structured as fixed or variable.
See your Doran Independent Insurance Agent today to discuss how annuities may be beneficial to you in meeting your financial objectives!
Primary source: Investopedia.com