Although annuities are not for everyone, the assurance of guaranteed income in retirement and tax-deferred growth can be very attractive for certain people looking to invest their money. Meanwhile, the high fees and mind-numbingly detailed contracts are a big drawback.
Here’s a look at whether an annuity might be a good investment for you.
What is an annuity?
An annuity is a financial contract, typically with an insurance company, that pays guaranteed income over time in exchange for what you originally paid either through a series of payments or a lump sum. There are a few different types of annuities to choose from.
- Fixed annuities offer a fixed payout over a fixed term and may guarantee a minimum rate of return, which can be appealing to those looking for a lower-risk option with lower fees.
- Variable annuities offer a payout linked to the performance of the underlying investments, such as stocks and bonds or both. Variable annuities have higher fees and offer no guarantees on returns.
- Indexed annuities offer payouts based on an index such as the S&P 500 or Dow Jones Industrial Average. Indexed annuities often include a minimum guaranteed return to mitigate market losses but carry higher fees than fixed annuities.
Annuities are also categorized by when the payout occurs.
- Deferred annuities pay out money at a later date, often during retirement.
- Immediate annuities usually begin paying out within the first year and have lower fees. Most people who buy an immediate annuity are already in or approaching retirement.
Pros and cons of annuities
As with any piece of your retirement plan, an annuity and other investments should make sense for you and your financial goals. Understanding the broad advantages and disadvantages of annuities may help you decide if an annuity is right for you.
- Regular payments through retirement or before
- Income for a set period of time or life, regardless of how long you live
- Tax-deferred growth
- Guaranteed rates of return on some annuities
- Survivor benefits
Cons
- High expenses and commissions
- Surrender charges if you want to exit
- Possibility of an insurer defaulting, though some protections do exist
- Highly complex contracts
Is an annuity a good investment for you?
Just as you’d consider your risk tolerance, time horizon and long-term financial goals for investing in stock or bond funds, it’s important to do the same for annuities. Although sold by insurance companies, annuities can still be part of building income for retirement.
It may be helpful to ask yourself questions like:
- What are my short- and long-term financial goals?
- How might an annuity fit into my overall financial plan?
- Is an annuity the best option to achieve my goals?
- Do I have the cash to buy an annuity after making other retirement contributions?
- Have I recently received a windfall, such as an inheritance or winning the lottery?
An annuity may be a good investment if you’re worried about outliving your savings – you might even be able to buy an annuity inside your 401 (k). Annuities may also be a good option if you want guaranteed income that could provide for your beneficiaries later on and feel comfortable taking on the cons, such as higher fees and navigating an exit if things change for you. If you’ve received a financial windfall or are planning for long-term care, an annuity may also be beneficial.
So is an annuity a good investment for you? That’s often a question best explored with a financial advisor, because annuities are complex and not the right fit for everyone. A financial advisor can offer individualized advice based on your long-term goals, current portfolio, income, retirement plan, risk tolerance and time horizon.
Need an advisor?
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Bottom line
An annuity may be a good investment if you want to ensure guaranteed income in retirement and don’t mind the drawbacks, such as higher fees and rigid contracts. An annuity might be beneficial, too, if you’ve received a windfall or anticipate long-term care expenses. Annuities are not a good investment for everyone, but there are pros and cons you may want to discuss with a financial advisor who understands your goals and current portfolio.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.
