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How to Choose the Right Annuity

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Annuities can be difficult to understand, and choosing the right one depends on the risk you want to take and the method in which you want the guaranteed income distributed. AnnuityAdvantage offers many different types for you to find the right one for you.

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What Is an Annuity?

An annuity is an investment available through insurance companies that guarantees a steady income stream in the future for an investment made either in one lump sum or through a course of monthly payments.

Annuities come in three types: fixed annuities, variable annuities, and indexed annuities.

Fixed Annuities

Fixed annuities establish an amount of income you’ll get in the future that’s irrespective of current economic conditions. Usually, this ‘fixed point’ is based on the current market index or the value of a specific index fund.

Immediate annuities also referred to as a single premium annuity, require you to pay out one lump-sum payment, after which you’ll start getting annuity payments, either for life or for the specified number of years in your contract.

Immediate annuities are most useful for individuals who are close to retirement or who have already retired, since doing so secures the money you’ve earned into a fixed income that is, at least mostly, impervious to market shifts.

Deferred annuities are another subcategory of fixed annuities that are, as the name suggests, tax-deferred. These annuities are often used by individuals wanting to prepare for a steady income during retirement.

The payout for this annuity only activates after the last payment on the annuity has been made. As such, this type is preferable for people who can make regular monthly payments but can’t manage the massive lump sum for an immediate annuity.

The best part is that if you’re opting for a deferred annuity, it can be converted to an immediate annuity so that you can start getting your steady income sooner.

Variable Annuities

Just like a fixed annuity, variable annuities can be immediate or deferred, allowing the investor to determine when the insurance company will start paying out a regular income.

Variable annuities differ from fixed annuities in that they put the investor in the driver’s seat when it comes to choosing where that money is invested, and the rate of return is dependent on the performance of the investment.

In other words, if the fund appreciates, you’ll get more money in your annuity payout, while depreciating investments will yield less return. When you invest in a variable annuity, you’ll be able to select a portfolio to invest in.

This selection process where you’re paying into the annuity is called the accumulation phase. A balanced fund is a popular choice for a variable annuity since it holds a mixture of promising stocks and bonds that are likely to earn a profit.

The amount of money you’ll be required to pay will depend on the performance of the funds you’ve invested in. While annuities are often secure investments, there is always a degree of risk, especially with variable annuities.

As such, you should always read the prospectus, a formal document required by the Securities and Exchange Commission (SEC) outlining the details of an investment to the public.

Reading this document can give you a more informed perspective on whether the fund is likely to improve the value of your annuity.

While a fixed annuity will guarantee a certain payout, a variable annuity is dependent on the market’s behavior. As such, you’ll benefit from and be harmed by the whims of the market to some extent.

Indexed Annuities

Lastly, indexed annuities work similarly to variable annuities in that they are credited based on the market value of a particular fund. The S&P 500, for example, tracks the performance of 500 large companies in the stock exchange market in the United States.

Depending on the change in this market index, you’ll receive either a higher or lower income. Most of the time, indexed annuities offer a minimum return that serves as a base payment that your income cannot go below.

Indexed annuities can be used to build up tax-deferred money, can be withdrawn at 10% per year, and can be fully withdrawn in the event that you are required to go into a nursing home.

Which Annuity Is Right for You?

Annuities can be confusing to understand, but they can be a sensible investment in some cases to prepare for the future. Fixed annuities guarantee a certain income, while variable and indexed annuities may fluctuate.

On all these annuities, you can pay extra for a death benefit, which ensures your loved ones will continue to receive annuity payments even if you pass away during the payout period.

On variable and indexed annuities, insurance companies will still often offer a minimum payout that’s guaranteed. Always take a look at what the worst-case scenario you can expect is if the market performs poorly.

For some, the answer to this question is none of the above. Annuities are generally best for long-term investments, so if you suspect that you’ll need the money you want to invest in the next few years, don’t get an annuity.

There’s often a surrender fee that will apply should you try to withdraw the principal early. In addition, annuities are not good wealth-building investments—they’re a security feature.

Most of the time, they don’t offer the same benefits as an IRA or 401(k) and won’t net you a significant return on your investments.

Even so, annuities are still useful for some people. Just make sure that you consider the terms of your annuity contract, consult with your financial advisor, and consider other options before being pressured into another decision.

The Bottom Line

Annuities are a type of investment that trades off profit for security. In an annuity—pretty much regardless of type—you can ensure a payout in the future to make retirement comfortable.

Fixed annuities offer a steady payout, while variable and indexed annuities tend to fluctuate depending on the performance of the investment funds.

Choosing the right annuity is dependent on how you want to invest your wealth, how you want it distributed back to you, and whether you’re willing to take risks for a potentially higher yield.