An annuity offers a stream of cash flow and the safety that you won’t outlive your income during retirement. Annuities are a popular retirement strategy, and you can buy them from an insurance company with a variety of features, depending on your specific financial needs and goals.
Here’s how to purchase an annuity and get passive income for life.
How to purchase an annuity: A step-by-step guide
Annuities are highly specialized products that offer a range of potential benefits, but they’re complex and difficult to get out of if you change your mind. So, the best place to begin is to evaluate your own financial needs.
1. Evaluate your financial goals
An annuity provides cash flow over an extended period of time, potentially for life. It also offers various tax advantages that can help you defer taxes on the investment. You’ll need to understand how that fits into your financial circumstances and whether an annuity is a good investment for you.
- What is your budget likely to be in retirement?
- Will you need to fill a gap in your budget with the passive income of an annuity?
- Does it make sense for you to earn lower long-term returns for the safety of an annuity’s cash flow, as opposed to potentially much higher returns in stocks?
- Do you need cash flow right now, or can you wait a decade or more until you need the income?
- Do you want an annuity that offers income for life or one that offers it for a fixed period?
- Do you want an annuity just for yourself or for a surviving spouse, too?
Annuities can provide a lot of features and benefits, meaning they can fit the needs of many individuals, though extra benefits increase the cost of the contract.
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2. Research the type of annuity that fits your goals
Once you’ve assessed your needs, you can determine which annuity may fit those needs. Annuities come in a variety of different types, depending on how they generate money and when you receive that money.
- Fixed annuity
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A fixed annuity guarantees a minimum return on your investment and will pay out over a specified term.
- Variable annuity
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A variable annuity invests in a variety of mutual fund-like assets that offer the potential for higher returns. The annuity’s return and payout depend on the investments’ performance and the expenses they charge.
- Indexed annuity
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An indexed annuity offers a return that tracks an index, such as the Standard & Poor’s 500 Index, which owns hundreds of America’s best companies. This type of vehicle usually caps your upside potential while providing downside protection.
Annuities can also be divided by when the cash flow begins.
- Deferred annuity
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Deferred annuities pay out at a specified time in the future, perhaps at some age in retirement, potentially after decades of growth.
In addition to these broad categories, annuities may offer a range of features that provide additional advantages, known as riders. For example, you can structure an annuity to offer a cash payout on death, much like life insurance. You can also structure an annuity to pay for a specific period of time, such as 20 years or even for life. Annuities can also be set up to pay out to a surviving spouse, ensuring that they continue to enjoy the annuity’s income for the rest of their life.
3. Choose your annuity company
Annuities are contracts that are typically created by insurance companies, so you can contact one of the best annuity companies to begin the purchase process. But you can also purchase them through a top financial advisor and some banks.
Annuities are not backed by the U.S. government, so you’ll want to select an annuity provider that has the ability to pay the contract’s claims. To select a strong provider, you’ll want to evaluate firms that have top financial strength ratings from A.M. Best or other rating agencies. It can also be worthwhile to look for high customer satisfaction scores, including from reviewers such as J.D. Power.
While it can be important to look for the best annuity rates, you’ll also want to consider other factors, such as whether the company offers annuities with death benefits (and how much), as well as their policy on surrender fees if you opt to close the annuity early. You’ll also want to know the company’s administrative charges, which can be hefty.
4. Submit your application
When you’ve decided on an annuity and a provider, you can begin the application process. Annuities are tremendously complex, and the contracts can run dozens of pages. It’s important to carefully read the document and fully understand your responsibilities and rights under the contract. You do not want to learn you’re not getting what you expected decades down the road.
You’ll need to fill out various personal and financial information as part of the application. Annuity rates change, so fill out the application in a timely manner if you want to receive those benefits.
5. Fund your annuity
You can pay for your annuity in different ways, depending on the type of annuity and its terms. You pay cash for the annuity but may be able to purchase it through a tax-advantaged account such as a 401(k), 403(b) or IRA. You can also choose to purchase an annuity with a single lump sum or fund the contract with a series of premium payments over time.
You may also transfer an existing annuity to a new annuity as part of a tax-free 1035 exchange. However, you may still pay substantial transfer fees for moving from one provider to another.
When is the best time to buy an annuity?
An annuity can be the right purchase at various points in your financial life.
For some individuals, it makes more sense to invest in lower-fee, higher-return investments such as stock index funds for decades. You can likely earn higher returns and pay lower fees, and then decades later invest in an immediate annuity if you decide you need the income then.
This approach can also work well inside a tax-advantaged account such as a 401(k), 403(b) or IRA. These accounts allow your money to compound in high-return investments without the drag of taxes, and then you can purchase an immediate annuity near retirement for the income.
Annuities can also make sense for higher earners who are looking for investments that earn tax-deferred income, especially once they’ve exhausted other tax-advantaged accounts.
Regardless of when you decide to purchase an annuity, it can make sense to begin investing early so that you give your money more time to compound.
Bottom line
If you’re considering buying an annuity, it’s important to carefully consider how it meets your needs. Because annuities are complex financial contracts, it’s essential to understand them fully — in particular, their costs — so that you know exactly what you’re buying and the benefits it provides.
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.
