Your Retirement and Annuities: Investing and Funding

The promise of lifetime income from annuities has been around for centuries dating back to Ancient Rome. Originally, annuities were just simple instruments that guaranteed a steady stream of income. But, things got more complicated as the years went by.



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For instance, in the late 1980s, variable annuities became popular when mutual fund subaccounts promised higher returns. During the following decade, index annuities provided conservative investors with a safe market participation method.

In general, all types of annuity contracts offer several key benefits, such as:

  • Contributions to non-individual retirement accounts or qualified contracts are tax-deferred with no limits on contributions.
  • Probate exemption
  • In most cases, you are protected from creditors
  • Providing protection from superannuation or outliving one’s income — the contract must be annuitized to accomplish this

The thing is, annuities are one of the most expensive types of investments. There are a lot of fees, charges, and other costs involved with annuities. As such, this can lead to substantial reductions in income and principal.

In fact, over the years, industry experts and regulators have criticized these contracts for their high expense ratios. And in the financial industry, the appropriate use of annuities is still a contentious issue.

Despite 401(k) and IRA contributions, you have a variety of ways to generate an income stream in retirement. Often, combining products is the best course of action. And. this also includes adding annuities to your retirement portfolio.

Optimizing Your Retirement Portfolio With Annuities

Investing in an annuity involves paying a sum of money upfront or over time and receiving guaranteed income during retirement. With immediate annuities, you can start receiving income between one month and one year after you purchase them. With deferred annuities, you can get that income at a later time.

In addition to providing retirement income, annuities can provide a fixed income stream for a lifetime. What’s more, the investment can be used to supplement other investments that may rise and fall throughout your retirement years.

Tax-deferred growth is also possible with annuities. As a result, you won’t be subject to tax on your gains until you withdraw them.

There are, however, risks involved with annuities, so they may not be suitable for everyone. Then again, they might make a good addition to your portfolio with the right research.

An annuity can, however, provide lifetime income, downside protection, and tax efficiency when used as part of your retirement portfolio.

Lifetime Income

An annuity can add a measure of predictability to your retirement portfolio when used as a source of income. In addition, you may be able to weather multiple market conditions over an extended period of retirement if you have an annuity. And, you’ll be able to meet your essential day-to-day expenses throughout retirement when you combine annuities with other predictable income streams, like Social Security.

Married couples can also benefit from annuities, providing them with a steady income stream after one spouse passes. In order to determine whether an annuity would be a good investment for you, you should carefully evaluate your retirement income sources and anticipated expenses.

Here are the annuities you can use as a source of income.

Income Annuities

  • Upon purchase, you can choose a future date on which you would like a lifetime income stream to start.
  • A savings component and liquidity are not included in this type of annuity.
  • As a result of purchasing insurance, you are giving up access to your principal in exchange for the income stream that is guaranteed by the insurer.

Fixed Indexed Annuities with Income Benefits

  • Index annuities do not offer direct investment opportunities in the stock market. Rather, they provide investment growth potential based on market indices, such as the S&P 500®.
  • Growth may be lower than actual market gains since gains accumulate tax-deferred and are capped to the index.
  • You can protect your retirement savings from market downturns with 100% principal protection.
  • For an additional cost, you can get lifetime income benefits. This provides slightly lower income than income annuities. On the flip side, you will retain some liquidity.

Variable Annuities with Optional Income Benefits

  • Professionally managed investment options that align with your risk tolerance and time horizon allow you to participate in the markets.
  • While continuing to defer taxes on growth, you can update your investment options.
  • Your annuity’s value will fluctuate according to the performance of your chosen investment options since variable rate annuities offer more growth potential than fixed rate annuities. You may be able to make more or less from your investment than it cost
  • With lifetime income benefits, you can ensure a minimum level of income with some liquidity for an additional cost. Compared to fixed indexed annuities, starting income is typically lower. You can, however, expect the income amount to grow more over time if you make good investments.

Downside Protection

An additional level of complexity can be added to retirement planning due to market swings. As a result, there’s an obvious concern among many investors about the security of their retirement portfolio. It is equally important for them to be able to generate sufficient income during retirement.

The good news? Adding certain types of annuities to your retirement portfolio can help protect your principal against market losses.

Insurance companies guarantee your principal when you purchase annuities, which can provide full or partial protection. During positive markets, many such investments can offer both asset protection and meaningful asset growth.

These are the annuity offerings for downside protection.

Fixed Annuities

  • Offers a predetermined, guaranteed return. As an example, with a Due Fixed Annuity, you get 3% a month on your money.
  • Choose from a variety of guarantee periods to meet your needs.
  • Savings can be withdrawn at the end of each guarantee period or re-opted at the current rate. In turn, this helps to protect retirement assets.

Fixed Indexed Annuities

  • Invest in market indices and get a return tied to the performance of those indices, such as the S&P 500®, over different time periods.
  • Growth may be lower than actual market gains since gains accumulate tax-deferred and are capped to the index.
  • Your retirement savings can be protected from market downturns with 100% principal protection.

Variable Indexed Annuities

  • The performance of market indices can also be tied to tax-deferred investment growth.
  • The use of buffers or floors primarily provides limited downside protection. A market loss that exceeds the buffer is the only risk to your principal during an index period. The loss is typically between 10 and 30%. It is usually 10% for the first loss. However, indexed annuities offer higher cap rates than fixed indexed annuities do.

Tax Efficiency

Through tax deferral, annuities build wealth and income for retirement. Deferred annuities earn interest without being taxed until withdrawn. Since interest compounds faster without tax withdrawals, deferring taxes accelerates savings growth.

Compounding is the process of paying interest on the interest that has already been earned. In most cases, money market accounts, savings accounts, certificates of deposit, and bonds that earn interest are taxable.

It will take longer for your savings to grow because you’ll have to pay federal (and sometimes state) income taxes on it every year.

But, you can compound your interest until withdrawn with a tax-deferred investment, such as an annuity.

It is important to note that annuities have some unique tax advantages. It is even possible to use them to pay for long-term care without paying taxes on distributions. Tax pitfalls do exist, however. Regardless, all types of deferred annuities are taxed as “ordinary income,” not as long-term capital gains.

Moreover, you can increase tax-deferred savings for retirement by investing in annuities if you have maximized your retirement savings in IRAs and 401(k) plans.

An annuity can be purchased in a retirement plan that already offers tax-deferred savings. But only if you want income or death benefits guaranteed by an annuity.

Annuities: How to Protect Yourself

If you want your insurer to meet its obligations to you long-term, you’ll need to be certain that it can do so. Ratings for financial strength can be easily found on A.M. Best Company’s website. Or, if you don’t want to register with AM Best, ratings can also be found on the insurer’s website.

Also, a state insurance department closely regulates annuity insurers by requiring them to file regular financial reports. Moreover, state guaranty associations insure annuities to certain limits if an insurer fails.

In addition to choosing multiple insurers, if you’re putting a lot of money into annuities, you’ll also be protected from the guaranty association.

FAQs

1. What are the different types of annuities?

In a fixed annuity, you receive a fixed return over a specified period of time. Investing in variable annuities can result in varying income amounts. Returns on indexed annuities are tied to an index, such as the S&P 500®.

If you’re not sure whether a specific annuity is right for your unique situation, you should consult a financial professional. They can provide you with the pros and cons of each type and what would work best for you.

2. Should annuities be your only retirement investment?

Short answer, no.

An annuity is an income stream you can combine with your other retirement savings, such as Social Security or an IRA, rather than replacing them. Before contributing to this vehicle, many financial professionals recommend contributing to 401(k)s and IRAs first.

3. What are the costs of annuities?

Annuities can carry high fees along with extra features (such as annuity income riders) that can enhance the final product. It’s also important to understand the ongoing costs associated with management fees. You should also consider the surrender charges associated with early withdrawals from an annuity.

Rather than capital gains rates, annuities are taxed at ordinary income rates. Consequently, your returns might be affected. The federal income tax penalty for withdrawals or distributions made before age 59 ½, sometimes called an additional income tax, may also apply.

4. Why is the strength of the company important?

With an annuity, it’s imperative that you purchase it from a company that’s reputable and financially sound. Since guarantees are based on an issuer’s ability to pay claims, they must be able to pay for many years. To protect your finances, you want to make sure the annuity company is around for a long time.

You can check the financial strength ratings with a company such as A.M. Best, Fitch, Standard & Poor’s, or Moody’s.

5. What risks are involved with annuities?

The purpose of annuities is to provide a steady income during retirement. In purchasing an annuity, you commit a portion of your retirement savings to a fairly illiquid product. As such, you might not be able to get out once you’re in.

Investing always involves risk. For example, you might die before you get much return. You may also find that inflation rises faster than expected, reducing the value of your annuity income.

Investing is subject to volatility, so you need to consider both the return and the principal value. As a result, when redeemed, your investment may be worth more or less than what you originally invested. For more information on the potential perils and options, talk to your financial professional.

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