Buying an Annuity: What to Know

If you’re thinking about financing your retirement, you may wonder how buying an annuity could fit into the picture. If you are wondering how to buy an annuity, where to buy an annuity, or simply whether or not you should purchase one, we have some guidance.

What is an Annuity?

An annuity is a contract you make with an insurance company. You pay either a lump sum or a series of premiums, and you get a guaranteed income stream for a specified time period or for the remainder of your life. (With some types of annuity, a beneficiary you designate receives payments after your death.) The insurance company invests your money in stocks, bonds, and other investments, and you receive payments according to the terms of your contract.

Is an Annuity a Type of Life Insurance?

No. Life insurance pays a benefit to your designated beneficiary after your death; an annuity is designed primarily to pay you an income stream during your life.

What are the Different Types of Annuity?

There are different types of annuity to meet different needs. Fixed annuities guarantee a fixed rate of return and are less risky than other types of annuity, but offer less growth potential; variable annuities, by contrast, offer greater potential growth, but also greater risk of loss, depending on the underlying investment vehicles. Indexed annuities are somewhere in-between: returns are based on the performance of a particular stock market index. Indexed annuities may offer a guaranteed minimum return, making them less risky than variable annuities. The type of annuity that is best for you will depend on your needs and risk tolerance.

Annuities may be categorized as immediate (you begin receiving payments immediately) or deferred (funds in the annuity grow tax-deferred until some later date when you begin receiving distributions). Both immediate and deferred annuities may be either fixed or variable.

Some annuities are qualified, meaning that they are purchased with pre-tax dollars and grow tax-deferred until you start taking payments. Others are non-qualified, meaning that they are purchased with after-tax funds. When you start taking distributions, only earnings on the investment are taxable to you.

Should I Buy an Annuity?

If you plan to retire soon and want an additional income stream, buying an annuity could be right for you. In addition to predictable income for life to supplement your existing retirement plan and Social Security, you can hedge against market volatility with a fixed annuity. An annuity is certainly worth considering if you are already making the maximum allowable contributions to your 401(k), IRA, and other retirement plans.

That said, you should speak to your financial advisor before committing to an annuity. You may be able to realize greater returns with other types of investments that offer greater flexibility and liquidity. Another consideration is that annuities often carry significant fees that other investments do not. Weigh the pros and cons carefully before purchasing an annuity.

Whose Not A Great Candidate For Buying an Annuity?

Annuities offer many benefits, but they are not right for everyone. One consideration is your life expectancy. Few of us know exactly how long we can expect to live, but if you have reason to believe you might have a shorter life span, perhaps due to a chronic illness, purchasing an annuity that makes payments only during your life might not be the best investment.

There are other reasons not buying an annuity is a valid decision, as well. If your existing investments and retirement plans will yield sufficient income for you in retirement, you may simply not need an annuity. You might also want to think twice if you would struggle financially to make premium payments in the here and now. Similarly, if you have financial goals in the short term that you would have to put off in order to purchase an annuity, you will want to think about where it makes more sense to put your money.

Last but not least, if you have not done your due diligence and thoroughly investigated the annuity you are considering, hold off until you can purchase with confidence—preferably after consulting with your financial advisor. You may be able to exchange an annuity if you later find one that better meets your needs, but it is wise to exercise caution before making a purchase.

What Should I Consider When Buying an Annuity?

There are a number of things to take into account when purchasing an annuity, including:

  • Risk tolerance: Is it more important to you to have the guaranteed income of a fixed annuity, or the opportunity for growth of a variable annuity?
  • Options for payment: Do you want to begin taking payments immediately, like you can with an immediate annuity, or do you prefer to defer payments until some point in the future?
  • Contract terms: An annuity is a binding contract, so make sure you understand all the terms and conditions, as well as any restrictions or limitations that it imposes on you.
  • Fees and other costs: Annuities often carry a “surrender fee” for early withdrawal, and there may be other fees as well, including administrative fees and sales charges. Understand how big a bite fees will take out of your annuity before purchasing.
  • Taxes: Like any investment, an annuity carries tax implications. Be sure you understand how your taxes will be affected both in the short and long term before committing your resources.

Other considerations involve whether a death benefit is available if that is important to you; be sure to ask about any additional associated fees. You will also want to know if and how long the interest rate on the annuity is guaranteed, and the company’s history regarding renewal of interest rates.

Where Can I Buy an Annuity?

Most often, buying an annuity through insurance companies is the case for people, and some insurance companies offer a wide range of annuities. You may also be able to buy an annuity through a bank, though you should expect a narrower range of options than an insurance company or even a brokerage firm might offer.

It is very important to confirm before buying an annuity that the agent and company offering the annuity are licensed in Ohio. As with many other types of investments, there exists the possibility that a company will fail or go bankrupt before you receive a single payment, or that the offer is a scam. Make sure the company has a solid rating, and remember that if something seems too good to be true, it probably is.

To learn more about buying an annuity, contact Gudorf Law Group to schedule a consultation.