3 things to consider before buying annuity
An annuity is an insurance plan in which the investor is promised a series of annual sums, immediately or in the future. These plans are a great way of collecting money for one’s financial needs. Typically, an annuity has higher fees and less flexibility than savings schemes like a 401(k) or IRA. Nonetheless, it can be a superb choice for individuals who have maxed out their allowable contributions on these accounts.
Investing in annuities
Wisely investing in annuities requires close consideration of several things, such as:
Type of annuity
There are three major types of annuities to choose from – fixed, variable, deferred, and immediate annuities. Each of these annuities has its pros and cons.
- Fixed annuities: In these arrangements, the investor is guaranteed a fixed sum at a later date. These annuities have lower returns, as the investments are generally safe and predictable.
- Variable annuities: Here, the investor splits the money in a mutual fund portfolio as the buyer chooses. The annuity received depends on the performance of these funds. These investments are ideal for seasoned investors who understand the market well.
- Deferred annuities: With a deferred annuity, the money stays in the account for longer, giving it more time to grow, resulting in a larger payout over time.
- Immediate annuities: As the name suggests, the payments here are quick – some beginning as soon as the first lump sum payment is made to the insurance company.
Cost of the annuity
Next, it is important to consider the cost of the annuity. In most cases, fixed-income annuities, deferred-income annuities, and fixed-indexed annuities (FIAs) do not have any associated costs. However, FIAs with living benefits and variable annuities may cost buyers between 0.5% and 6% of their contract value. Before buying any of these annuities, one must carefully consider the overall costs to ensure they are not losing their hard-earned money.
In addition to the cost of the annuity itself, buyers must also be aware of how much they can withdraw from these annuities in a year. This value must align with one’s financial needs and goals, offering a way to save for the future without compromising the present.
Associated tradeoffs
Another important aspect to pay attention to when buying an annuity is the associated tradeoff or risk. Every benefit that comes from an annuity is related to some type of risk, such as the loss of capital liquidity and reduced purchasing power with a fixed-income annuity or the loss of value of an investment with variable annuities.
To be aware of these pitfalls, investors must read the disclosure documents carefully and speak to a company representative to clarify doubts or queries. Buyers must also check the company’s financial rating via a third-party rating service to be confident regarding their investment.
