A person who is in retirement or nearing retirement age will need to make some decisions about the management of their retirement nest egg. One way to use the money is by purchasing an annuity that will convert the nest egg into a steady stream of payments that a person can use throughout his or her retirement. There are a number of advantages of choosing an annuity for a retired person to consider.

Guaranteed Payment Amounts

Most investment choices have risk, yet a fixed annuity offers the investor a guaranteed payment amount. Generally speaking, annuities are insurance products and therefore most are backed by highly rated companies. In most cases, a retired person who chooses to buy a fixed annuity will receive a set monthly payment for as long as he or she lives. Most annuities also provide a guaranteed payout amount if a person would pass away soon after purchasing the annuity.

Whether fixed or variable, an annuity has many definitions. Does it have a place in your financial plan?

Peace of Mind

Annuities offer retirees peace of mind as the money in the annuity is fully guaranteed. Unlike stocks and bonds that can decline in value, an annuity’s value is protected by both the financial strength of the insurance company as well as the backing of an insurance company. The purchase of an annuity also removes one of the greatest financial fears of retirement: running out of money.

Steady Stream of Income

Financial planning is one of the most difficult parts of retirement. However, the guaranteed payments from an annuity can help a retiree to craft a budget and make wise spending decisions. With an annuity, a retiree will know how much can be spent on various expenses such as a mortgage, rent or automobile payments without worrying about whether or not money will be available in future years to make those payments. Let’s face it, even a million dollars isn’t worth as much as it used to be. With a steady monthly check an annuity might be a good choice to steady your financial ship.

Tax Planning

Annuities purchased with after tax dollars will result in payments that are not subject to income taxes, with the exception of the small portion of the payment derived from interest. This means that a retired person with an annuity will not need to worry about rising tax rates significantly impacting his or her payment amounts. Conversely, retirees with money invested in the stock market will need to worry about tax changes that may impact his or her retirement income.

Simple Management

Annuities do not require constant management like other types of investments. Once an annuity is chosen, the owner of the policy does not need to make changes with the investment. This means that instead of choosing stocks and bonds, monitoring returns and rebalancing portfolios, retirees with an annuity can spend more time relaxing and enjoying life.

What Is A Variable Annuity?

A variable annuity doesn’t usually guarantee a set payout per month or year. Instead, the payout is based on the appreciation of the underlying assets that the annuity is invested in. Sometimes your value will increase and sometimes decrease. Therefore, this is known as a variable annuity. These can be very profitable during the boom times of the stock market. Brokers can show you on paper and with a calculator how much money you are going to make (as long as the market continues to climb). However, since this is a “variable” annuity, expect the income to vary widely depending on what the market does.

Potential Downside of an Annuity

The biggest gripe people have about annuities usually revolve around their fees. These costs can actually be quite substantial depending on the specific annuity that is purchased. Since these investments are often sold by insurance brokers, the fees can climb as high as 10%. You need to research this further but this might erode any potential benefits you a seeking from the annuity. Another downside to an annuity is that if you need to pull the money out of the annuity within a few years of purchasing it, you will likely need to pay “surrender charges.” This is basically a penalty for pulling your money out sooner than the insurance company wants you to. Finally, if you are looking into a variable annuity then you always face the danger of the underlying investments declining in value. Remember the dog days of the stock market in 2008 or so? If you owned a variable annuity during that time that happened to invest in the United States stock market, you got hammered.

Contribution Limit For An Annuity?

This is often seen as a benefit to investors in certain situations as there is no limit to the amount you can put into an annuity. Unlike a 401k or IRA, there are no contribution limits. This allows investors to have their money grow inside of the annuity without facing a tax bill from Uncle Sam. This might be particularly attractive to older investors who are trying to sock away as much money as possible prior to retirement.

Investments Within The Annuity

If you choose a guaranteed annuity, you won’t have any say-so in what investments are held by the annuity or the insurance company that holds it. However, if you choose a variable annuity you might have some leeway. More than likely there will be a list of mutual funds into which you can have your variable annuity invested in. Of course, you will want to get all of this in writing as part of the annuity purchase so you know exactly what you are buying, and what your investment options are.

Annuity as a term with a long definition

Payout Options For Your Annuity

The payments you receive from your annuity could take several different forms:

  • Guaranteed income for a specific period of time. The annuity could make payments for 10 years, 20 years, or some other period of time. The key is that this type of annuity is for a specified period of time.
  • Lifetime payment option. This type of annuity offers payments until the time at which you die. There are no survivor benefits under this scenario.
  • Income for life but with a guaranteed period. This is a sort of “combo” of the other options. You will receive benefits for your lifetime, however, if you die within the specific guarantee period, your heirs will receive the final payments in the guarantee timeframe. As an example, if you have a guaranteed benefit of 8 years, and you die 4 years in, your heirs will receive the final 4 payments due and then payments will stop.
  • Joint and survivor annuity. This is potentially a good option for married couples as the benefits continue after you die, and are transferred to your spouse until the day they die.

Though financial planning can be complicated and stressful, the decision to purchase an annuity has a number of advantages over other retirement options. An annuity can provide a person with the income needed to relax and to have an enjoyable retirement.

Jason

Founder of FinancialSumo.com, his writing has appeared on many financial, entrepreneurial and small biz sites across the internet. When not writing, Jason enjoys spending time with his family in San Diego.
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