Fixed and variable annuities can have a major role in retirement planning. They must, however, match your retirement objectives. That requires that you evaluate their suitability carefully.
Your financial planner and you are responsible for determining if including an annuity in your retirement plan is appropriate. What is your goal? What are your requirements? How would fixed and variable annuities fit your needs?
Financial planners are not mind readers. They need to ask you a number of questions to determine your objectives and the appropriateness of any annuity. In medical terms, the diagnostic phase must precede any treatment.
I am not a financial advisor. Accordingly the information presented is for informational purposes only. It is not financial advice.
A fixed annuity is a contract with an insurance company. The payouts are at a fixed interest rate.
If you purchase a fixed annuity with a lump sum payment and expect immediate payments from the insurance company, it is a single premium immediate annuity (SPIA). It is the mirror image of life insurance in which one makes regular payments to the insurance company and beneficiaries receive a lump sum payment upon death. The SPIA is a lump sum payment to the insurance company with regular payments received by the annuitant – often until death.
We will discuss the various “riders” on another page. However, it is the cost of the rider modifications that help to determine the fixed interest rate or the amount of the monthly payment.
Purchasing an annuity is both an emotional and financial decision, as it is a long term investment and the insurance company controls the money.
Regaining control of the premium is nearly always expensive and may not be possible. It is wise to consider that the money is unavailable for many years or forever.
The other way to purchase a fixed annuity is with periodic payments. Because the payments are deferred to a later date, this is known as a deferred fixed annuity.
A periodic payment purchase earns interest during the purchase period. These earnings accumulate tax-deferred at a fixed interest rate.
Fixed annuities provide a safe, guaranteed income. The interest rate may be considerably better than a CD or bond. These annuities are easy to understand, the payments are guaranteed, and the principal is usually safe.
A variable annuity is also a contract with an insurance company. The payouts vary according to how the money is invested within the contract.
As a reminder, there are two ways to buy an annuity. One is a lump sum payment. The other is with periodic payments. Also, with either method of payment the insurance company payments can be delayed or deferred.
When insurance company payouts are deferred the earnings within the annuity contract accumulate without being taxed. Those earnings will be taxed as ordinary income when they are withdrawn. In fact, any earnings within an annuity will be subject to taxation.
Variable annuities do not have a constant rate of return. The investment return varies, depending on the performance of the managed portfolio. Usually the money is invested in one or more of the available mutual fund subaccounts.
The risk is greater than it is with a fixed annuity, but so is the potential for a greater return. It is also possible that a variable annuity will lose money.
Always keep your investment objective in mind. Annuities are long term investments designed to generate a steady income during retirement.
Adding another feature to this description is the fact that periodic payments may be flexible, that is, less or more than the amount listed if permitted by the contract. Also, the insurance company payouts may be adjusted in many contracts. All of these variables make annuities seem very complicated.
I believe anyone selling fixed and variable annuities should try to simplify their presentation of annuities by explaining these two things first.
There are two methods of purchasing annuities: lump sum and periodic payments. The periodic payment method is called a “deferred annuity” because the payouts are deferred to a later date.
There are two types of annuities: fixed and variable annuities. There are countless variations of these two types. In fact, these two types can be blended together to form an entirely new form of annuity, that I call a hybrid.
After that is understood by the client, it is time discuss the many nuances or “riders” that complicate one’s choices when purchasing an annuity. Finally, do not expect insurance companies to use identical terminology.
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