5 Reasons Why You May Need an Annuity
This article will ...
Define what an annuity is and note the different types of annuities that are available.
List five specific reasons to buy an annuity to help achieve a particular retirement or investment goal.
Describe the complexity and risks to consider when contemplating who needs an annuity.
Annuities are a group of products that generally ― in exchange for a lump-sum payment or a series of payments ― can provide an income stream at some point in the future. There are many different types of annuities with different benefits and features aimed at accomplishing different things.
For instance, some annuities are designed to help people build long-term savings for retirement, while also offering the ability to turn those savings into a guaranteed income stream. Other types of annuities are specifically designed to help those who may need retirement income immediately or in the future.
The overall mix of annuities provides a range of options for meeting certain needs and circumstances. What are some of the most common reasons people buy an annuity?
Often, depending on the type of annuity, they can help when you need to:
Here’s a closer look at each of these areas.
Meet retirement income goals
Will you have a steady, predictable stream of income in retirement?
Retirement income can come from a variety of financial sources, which, when added together, can allow you to maintain a certain standard of living. Some of those sources, like Social Security, can be stable and reliable. Others, like retirement and investment portfolios comprised of securities tied to the market, may not be.
As a result, a market downturn or other economic event can have negative consequences for the amount and reliability of your retirement income stream. (Related: Your 401(k) is Maxed out - Now What?)
Annuities can provide a guaranteed source of income and, as a result, can bulk up the stability of a retirement income plan. With income annuities, that stream of income can start immediately or at some specific point in the future.
These types of annuities can offer a solution for those nearing or entering retirement needing an income stream. The guaranteed income derived from income annuities can also help lessen the effect of withdrawing income from an investment portfolio in a down market.
Or course, there are trade-offs. Because they provide limited or no liquidity, guaranteed-income annuities generally are not the best choice for those who want to be able to tap the underlying funds.
Prevent outliving assets
What’s another concern, especially for those entering or nearing retirement?
Thanks to improvements in health care and standards of living, people are living longer. A 60-year-old today can expect to live at least another 20 years or more, on average, according to the Centers for Disease Control. (Related: Prepare for Longevity)
That means people need more money to live on through their golden years, which can be a challenge. A retirement investment portfolio may not have enough funds to last forever, especially if funds are drawn from it every year. Pensions are on the decline, and Social Security, a government program that has its own funding worries, may be unlikely to fulfill the desired level of income needs for many people.
By providing a guaranteed and predictable stream of income that lasts for your lifetime, annuities can help offset the challenge of making income stretch over what may be longer-than-expected years.
Also, a certain kind of annuity can help cope with the rules and regulations that sometimes force money out of retirement accounts in a way that does not perfectly align with the growing longevity of today’s Americans. Called a qualified longevity annuity contract (QLAC), it’s a type of annuity that can be bought with money from qualified retirement accounts and delay required minimum distributions and their associated taxes.
Diversify an investment portfolio
Stocks and bonds, either directly or indirectly through various types of funds, are the mainstay of most retirement and investment portfolios. As such, market swings can affect their performance and, subsequently, their growth from year to year. That can present a challenge, especially for those who may be facing retirement in bear-market years.
Other types of investments, like commodities or real estate, are also subject to boom and bust cycles in markets.
Various types of annuities can offer diversification with varying degrees of market exposure. That can help investors looking to save and build resources over time for retirement.
For instance, deferred fixed annuities offer guaranteed interest rates and protection from market volatility. That can help stabilize portfolio growth.
For those who might want a little more upside potential, fixed index annuities can earn interest based in part on the performance of an external index. They also provide protection against market downturns.
And for those who can tolerate more risk in exchange for market gain potential, variable annuities offer a range of investment choices. Additionally, many variable annuities offer riders that guarantee the ability to withdraw or annuitize certain amounts, regardless of market performance.
Of course, because annuities are insurance contracts, the backing of a strong issuer is a key consideration.
Help manage taxes
Deferred annuities allow for tax-deferred growth and accumulation, which can help build a retirement nest egg. It is important to note that annuities do not provide additional tax-deferral for qualified assets such as IRAs.
Also, depending on the type of annuity, they may help manage capital gains tax consequences.
For instance, as mentioned earlier, variable annuities are designed to offer market exposure to those seeking investment gains over and above the guaranteed or interest-rate-based returns offered by other types of annuities. Investors can generally defer paying taxes on any gains within the variable annuity until the money is withdrawn or starts being paid out as income.1
Customize your financial plans
As noted above, there are many types of annuities, each with features and mechanisms aimed at accomplishing certain purposes. Some annuities are geared more toward those looking to build retirement funds for the future through diversification, tax-deferred growth, and accumulation. Others are designed to fulfill more immediate retirement income needs.
These varying features can offer opportunities for investors to target certain goals in their financial plan.
For instance, a small-business owner who wants to retire could look to a deferred income annuity as a way of simulating a corporate pension.
Also, annuities can come with special provisions that can allow for death benefits, optional living benefits, survivorship benefits, or other considerations such as terminal illness and nursing home riders to meet someone’s individual circumstances.
But along with the range of features comes a range of risks and costs. That’s why it's important to fully research and understand any specific annuity before purchasing it. Many people opt to consult a financial professional to help understand an annuity and how it can fit into an investment or retirement plan. (Need a financial professional? Let us know or find one here.)
1 There may be tax penalties for withdrawing funds from an annuity prior to age 59 ½.
Any guarantees explicitly referenced herein are based on the claims-paying ability of the
issuing insurance company.