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What Annuity is Right for Me? and Is an annuity a good investment? are two frequently asked questions on the AnnuitySeeker site. As with any other financial product, to determine if an annuity is right for you, you need to understand what your goal is with the money you plan to invest in the annuity.
Annuities are the right investment option for some financial goals and the wrong option for other financial goals. Below we list some financial goals for which fixed and fixed indexed annuities are suitable, and some goals for which these types of annuities are not suitable.
Annuity is Right for Me if…
- I need a guaranteed income
- I want tax-deferred growth
- I have the time to let my compound interest and make it grow.
- I need an immediate monthly income from my investment
- I need a better interest rate than a bank savings account
- I want to guarantee my principal and interest earned against any loss
- It is important to leave money to my heirs
- I want to participate in the gains of the scholarship
- I want to avoid stock market risk
Annuity is Not Right for Me if…
- I need immediate cash flow at more than 10% of my balance per year
- I only want to make a short term investment
- I want to use this money before I turn 59.5 years old.
- I am looking for a high-risk, high-yield product
Fixed and fixed indexed annuities can be the ideal solution for most of your retirement goals. When these annuity products are part of a comprehensive retirement strategy, they can provide you with guaranteed income and impressive interest potential, while protecting you from loss of value due to stock market fluctuations.
A fixed index annuity (FIA) can allow you to participate in some of the upside gains of a growing stock market, while protecting you against losses if the stock market declines.
A Fixed Rate Annuity (FA) can provide you with monthly income for the remainder of your retirement.
AnnuitySeeker has also listed a few concrete examples of how annuities have helped people plan for retirement.
What Annuity is Right for Me? Liquidity Considerations
When assessing the liquidity of financial products, it is important to determine the level of liquidity required by your situation. Most financial products provide access to 100% of your current balance, but liquidity is determined by the cost of withdrawing that money from your account. Liquidity costs are usually realized in the form of commissions, fees, penalties and/or taxes.
Some financial products, such as bank savings accounts, offer 100% liquidity at no cost and other products, such as fixed-rate or fixed-index annuities during the redemption period, offer free liquidity up to a specific percentage of your account balance (often 10% per year).
To determine how much cash you need, you first need to define why you need cash. Some investors really need 100% cash.
Example: Bob has $100,000 to invest today, but he plans to use all of that $100,000 to help his daughter buy a new home in one or two years. Bob will need 100% cash at the end of one year.
However, some investors don’t need “100% cash”. They need cash access to their funds primarily for day-to-day emergencies such as a new water heater, car repairs or unexpected medical expenses. In these situations, they are unlikely to need 100% liquid access to their investment.
Example: Mary has a fixed index annuity with a 10% free withdrawal allowance and a balance of $200,000. During Mary’s redemption period, she is suddenly hit with a roof repair charge of $8,000. Marie will be able to withdraw up to $20,000 from her pension without incurring a penalty charge. In this case, the pension has provided enough cash to cover the cost of repairing Mary’s home and she still has cash left over to use for future emergency expenses. Mary will continue to have access to 10% of her pension funds per year during her “buy-back period” (usually 7 to 10 years), and then she will have access to 100% of the balance of her pension at no charge after the end of her buy-back period.
*Some financial products, including many fixed rate and fixed index annuities, provide 100% free access to your funds in the event of the annuitant’s catastrophic illness or death. In these emergency cases, you have access to your funds at no charge.
Finally, money invested in a fixed-rate or fixed-index annuity is never locked in at any time. You will always have access to your funds. If you need to withdraw more than your free withdrawal limit, you can do so, but you may have to pay surrender charges.
What Annuity is Right for Me?…In summary
As a general rule, you should consider an annuity only after you have exhausted other tax-efficient retirement investment vehicles, such as 401(k) plans and IRAs. If you have extra money to set aside for retirement, tax-free growth of an annuity can make sense, especially if you’re in a high tax bracket today.
Annuities have significant drawbacks. First of all, you have to be prepared to put that money away for years. If you make a withdrawal in the first five to seven years, you’ll generally have to pay surrender charges of up to 7% or more of your investment. Annuities often have other high fees, including an initial commission of up to 10% of your investment. If you buy a variable annuity, investment management fees and other fees often amount to 2-3% per year.
These fee structures can be complex and unclear. Insurance agents and others who sell them can tout the advantages and minimize the disadvantages, so be sure to ask lots of questions and carefully review the annuity plan first.
Before you invest, you should compare this fee structure with that of regular no-load mutual funds, which do not charge any sales or redemption commissions and have average annual expenses of less than 0.5% (for index funds) or about 1.5% (actively managed funds), and determine whether it would not be better for you to go down this road on your own.
It’s also important to understand that the income you withdraw from an annuity will be taxed as ordinary income, regardless of how long you hold the account. The top tax rate today is 39.6%, but if you have some time before you retire, you can be sure that tax rates will not increase.