An annuity is a special type of insurance product. Rather than providing money to your beneficiaries at the time of your death like a life insurance policy, an annuity provides you with an income while you are alive in the form of periodic payments. If you are concerned about having money to live on after your retirement, it makes sense to understand the pros and cons of an annuity.
Identification
Annuities may be either fixed or variable. During their growth period, fixed annuities will earn at least a guaranteed minimum rate of return, while variable annuities will earn amounts based on investment performance. When you receive periodic payments from your annuity, fixed annuities will pay a guaranteed amount per dollar in your account, while variable annuities will pay an amount that cannot be guaranteed ahead of time because it is based on investment performance.
Investment Potential
On the plus side, annuities do earn interest during their growth period. However, if you are purchasing an annuity to provide a guaranteed future income, your choice of a fixed annuity will impose certain growth limits when compared to a variable annuity. A variable annuity may offer you more investment potential, but with that potential comes increased risk. A fixed annuity will usually guarantee that you get back at least as much money as you initially invested in purchasing the annuity.
Loss of Flexibility
Annuities do not offer the same degree of flexibility as some other investments. While you may be able to withdraw money from other investments if you have a financial hardship, for example, you generally will not have that option with an annuity. Plan for unexpected hardships and expenses separate from an annuity.
Spousal Support
Only some annuities provide a death benefit. You may want life insurance in addition to an annuity if your spouse or family will need money at or after your death. Some annuities will make payments to a spouse or beneficiary after your death. Consider the needs of those who rely on you for financial support when you make your financial decisions.
Outliving Your Assets
A common concern among seniors is outliving their assets. An annuity can be structured so that you receive payments for your entire life, no matter how long you live. Annuities can also be structured to keep pace with inflation, although such annuities are generally more expensive to purchase.
Taxes
Earnings on annuities are usually tax deferred. If you use the proceeds of a qualified retirement savings plan to purchase a qualified annuity, you may be to avoid any tax penalties. You will pay income tax on the income you receive from the annuity. For a complete understanding of current tax laws and how they will affect your situation, consult a financial planner or certified public accountant.
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