In simple terms, an annuity is an agreement between you and your insurance company. This agreement allows you to pay now into a tax-deferred account (in either a lump sum or series of payments) with the understanding that you will receive an income in the future.
Let’s dig a little deeper to discuss the variety of options an annuity can offer.
How an Annuity Works
Annuities are most often used as retirement planning tools. In this case, you would purchase an annuity to ensure that you would receive a lump sum or steady stream of income following retirement.
If the annuity is set up as a series of payments, you can choose a plan that provides income for the rest of your life. You could not outlive the annuity, which is why it serves as such a comfort to those who are unsure they’ll have enough money after retirement. This isn’t always the case, however, as you can also choose to receive the income for a specified amount of time.
The type of annuity you choose and its terms depend on your goal.
Four Types of Annuities
There are four popular types of annuities:
1. Variable
This type of annuity provides you with more control over your assets. Variable annuities are based on investments, meaning that you can choose between sub-accounts to invest your money. Your future income from this annuity is determined by how well your investments perform. Though it holds a certain amount of risk, as any investment does, a variable annuity offers the possibility of significant growth.
2. Fixed
A fixed annuity carries less risk than a variable annuity. This type of annuity has a guaranteed interest rate. Unlike a variable agreement, you will receive the exact income you expect when the time comes. This annuity is an excellent choice for those who are more risk-averse.
3. Fixed Indexed
A fixed indexed annuity is somewhat of a hybrid of the previous two we’ve talked about. Like a variable annuity, the fixed indexed gives you the opportunity for growth. However, it doesn’t come with all the risk of a variable annuity, as a fixed indexed annuity protects your principal when the market is down. For those who are moderately risk-averse, this may be their best option, as they get a taste of both worlds.
4. Immediate
Immediate annuities allow you to pay a lump sum in exchange for an immediate stream of income. This income can start as soon as you pay, or you can defer payments for one year.
What to Consider When Purchasing an Annuity
As we mentioned, the type of annuity you choose largely depends on the result you would like to see. Here are a few considerations to focus on:
Risk Tolerance
This factor will help you determine between variable, fixed, and fixed indexed annuities. The level of risk you are willing to take, or the level of risk your advisor suggests is best, could make your decision.
Term Length
As retirees are living longer, many choose to receive a steady stream of income for the rest of their lives. Consider what will benefit you most in the long run—one lump sum, a stream of income for a set amount of year, or a stream of income that you cannot outlive.
Overall Need
An annuity isn’t a cure-all for retirement savings. It’s a tool that can be leveraged to provide for you, just as your 401(k) or your IRA is there to serve you in the future. Discuss your interest in an annuity with a financial advisor before you make a final decision. They will provide insight into whether this is the right tool for you and how it works with your overall financial health and long-term plan.
How You Can Get Started
Southwestern Investment Group is here to help. Our advisors are experts in retirement planning. We analyze your current finances, listen to your dreams and goals, and design a plan that fits your needs. If you’re considering adding an annuity to your investment portfolio, reach out to a Southwestern advisor near you to explore your possibilities.
Contact us today to see how our advisors can pave the way to your financial success.
