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How to choose the right annuity
Purchasing an annuity can be a great way to guarantee your retirement income for as long as you live as well as protect your assets from inflation, stock market fluctuations, a serious medical crisis or other unforeseen circumstances. However, like most retirement financial products and services it is best to sit down and carefully figure out how an annuity can or cannot fit into your general plan for retirement. Below, you will find in-depth information on annuities that will give you many of the facts you will need to make a decision. We will describe the benefits and drawbacks of certain types of annuities and then discuss broader issues regarding annuities in general, so that you will be able to weigh what is most important to you.
There are four main types of annuities, fixed lifetime annuities, fixed term annuities, variable lifetime annuities, and variable term annuities. While there are some variations to consider when thinking about these annuities, we will get to those in the end of this article under “further considerations”.
Fixed Lifetime Annuities
Fixed lifetime annuities are usually considered by financial advisors to be the safest bet for a retiree. These types of annuities allow you to purchase a guaranteed monthly income for the rest of your life. This monthly income is not prey to stock market performance since it is based on something fixed like a bond, which is why many consider this the safest bet. Also, if you live to a ripe enough age your annuity can pay a higher sum than you originally invested. However, there are two drawbacks to this type of annuity. One, it provides for less flexibility because you have a guaranteed income so if the market is doing well you will not receive more income. The second drawback would be if you happen to pass away before you recover your initial investment in the annuity, then unless you have premium protection (see “further considerations” ) you will lose whatever investment money is left on your annuity.
Fixed term annuities
Fixed term annuities provide a guaranteed income over a specific period of time, say 5 or 10 years. Fixed annuities might be a good consideration if you know exactly how long you are going to live or if you know that your income needs will decrease as you age. If not, then most advisors would suggest a lifetime annuity.
Variable lifetime annuities
Variable lifetime annuities provide a lifetime income, like fixed lifetime annuities. However your monthly income will depend on the market and more specifically the underlying fund for which the annuity is based. Variable funds are a riskier investment in retirement but, just like most risks, you could end up doing considerably better if you play your cards right.
Variable term annuities
Again, similar to fixed term annuities except your income is based on the underlying fund.
Drawbacks
While annuities will provide you with a steady income, subject or not subject to market conditions, depending on the type of annuity you purchase, there are some general downsides to annuities that you should definitely consider when evaluating your options.
One drawback is that annuities are inflexible because they tie up your lump sum of money into an annuity, reducing your overall liquidity. As such, many financial planners agree that you reserve at least 40% of your retirement assets for unforeseeable circumstances. There are third party lenders that will buy your fixed income payments for a lump sum, but normally you should do this only if absolutely necessary.
Further considerations
First and foremost, make sure that if you purchase an annuity that you purchase one from a reliable and trustworthy financial advisor. Make sure to ask for references and talk to his/her other clients. Your retirement is too important to go to the advisor who gives you the best “deal”.
Here are some other items you should make sure to address:
- COLA- Consider purchasing an annuity with “cost of living adjustments” (COLA), which protect the value of your income stream by adjusting your payments along with inflation or the cost of living.
- Joint and Survivor Benefits – Annuity products can be tailored to accommodate one person or a family. If you are married, you will probably want to purchase an annuity that guarantees your own income – as well as your spouse’s financial welfare after you die. Furthermore, if you pass away before you get a return on your investment, the remaining money can go to your heirs.
- Finally consider using your 401k or IRA funds to purchase an annuity as this purchase will end up being tax free, the only taxes you will have to pay is on the income the annuity will end up giving you.
- While we have tried to cover most aspects of annuities for you to get started on the right decision, our final suggestion would be to talk to a reputable financial planner about your current situation and what you desire from your retirement. That way you will be able to enjoy your “golden years” ahead. Good luck and happy retirement!
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With the new marketplace for annuities they are actually becoming more flexible. Some of the annuities nowadays have death benefits and side accounts that you can access in case of an emergency. This is not their main purpose but it does provide some flexibility to offset their drawbacks.
I also think one of the keys to fixed term annuities are annuity ladders. Similar to CD ladders except for income.
Finally, I’m really confused about your use of the words “tax free” when you mention using retirement monies in an annuity. They are the opposite of “tax free”, they are fully taxable.