The idea of a regular source of income is very attractive to many investors — especially retirees. It’s not surprising, when you consider that the recent stock market crash decimated a number of nest eggs. And, even though the stock market has recovered and then some, there are still concerns about volatility, and fears about the next crash.
How the Annuity Works
Annuities are usually offered by life insurance companies. You pay in a certain amount of money, and you are promised a regular income at a certain date. The insurance company takes the money you pay in and invests it. The idea is that the investments will be enough to cover your payouts — plus result in profit for the insurance company. There are also fees charged, and the possibility that you will not receive your benefits to provide income for the insurance company.
You can choose to pay a monthly premium to an annuity for a set amount of years. Once you have reached a certain age, or paid in for a certain amount of years, you start receiving payments. Unfortunately, the returns on this type of annuity, over time, are often rather low. You can choose to have you annuity indexed in the hopes of improving your returns, and boosting your payout, though.
Another option is the immediate annuity. With this annuity, you pay a lump sum. This lump sum effectively “buys” you a certain regular payout. It can be for a set number of years, or it can be an indefinite payout for life. The immediate annuity is one of the more popular options for retirees, since they can take a portion of the money in an IRA or 401(k) and use it to buy an annuity that offers a baseline regular income. This way, the retiree knows exactly how much he or she can expect each month, and it provides a measure of safety in the event that the rest of the portfolio runs into problems.
You can also purchase a deferred annuity with a lump sum. In this instance, you make the purchase, but agree to wait between 10 and 30 years to begin accepting payouts. While the other types of annuities often come with beneficiary opportunities for your heirs, many deferred annuities do not. Your premium is lost if you die before you begin receiving payouts. If you do choose to designate beneficiaries, you can expect a smaller payout.
Annuity payouts depend on how much money you put into the annuity, as well as how long you expect to receive payments. Indefinite payouts are much lower than those that have a time limit. Additionally, your payout can depend on whether you have a fixed annuity (guaranteed rate of return), variable (based on market conditions, and there is the chance of losing some principal), or hybrid (a low guaranteed fixed rate of return, but with variable properties to enable you to earn more).
Before you invest in an annuity, do the research and consult a knowledgeable financial or estate planner. Watch out for fees, and learn about the tax implications and beneficiary issues that can come with these investments. While annuities work well for some, they are not the best options for others.