The hot investment of 2023 is… annuities? That's right; in the realm of retirement planning, annuities are experiencing a remarkable renaissance, with more people buying them than ever before.
Once you know what an annuity actually is, it's easy to see their draw. These financial vehicles are beloved for their promises of high payouts and guaranteed income - and thanks to rising interest rates, insurance companies are now guaranteeing better returns than we've seen in a dozen years.
In a financial climate filled with uncertainty, annuities stand out as a beacon of stability, drawing in investors who are eager to bolster their retirement funds and carve out a path to a financially secure retirement. Sound like you? Read on to learn what an annuity is, how it works, and how you can add one to your retirement plan today.
The Advantages of the Current Annuity Boom
Annuities are currently enjoying the limelight in an investment landscape where stability is highly prized. The appeal is rooted in their ability to offer guaranteed returns that are insulated from the stock market's volatility. Fixed annuities, in particular, have emerged as stars, offering rates that outdo traditional safe havens like CDs and Treasury notes. This has led to a significant uptick in annuity investments, with a 22% increase to a record-breaking $310.6 billion last year — and the trend shows no signs of waning.
Fixed annuities are currently offering guaranteed rates that are exceptionally competitive, some even scaling the heights of 5.2%. By opting into an annuity now, investors can clinch a rate of return that's been elusive for years.
And unlike stocks, fixed annuities are immune to the unpredictability of the stock market, making them a retirement haven for those who prioritize financial stability. These annuities are not just instruments for generating immediate income; they can play a pivotal role in a well-rounded retirement portfolio, offering some important diversification to more volatile investments.
Annuities: Understanding How They Guarantee Income for Retirement
Let's talk about what an annuity is and how it works.
An annuity is a financial contract between you and an insurance company that allows you to pay money now in exchange for a guaranteed and steady stream of income. You can pay the insurance company either a lump sum or through a series of payments. In return, the company promises to make periodic payments to you starting immediately ("immediate annuities") or at some point in the future ("deferred annuities"), depending on the terms you choose.
- Immediate Annuities: Suitable for individuals who require immediate income after a lump sum payment, such as a settlement or lottery win.
- Deferred Annuities: Designed to grow tax-deferred and provide guaranteed income at a later specified date.
Annuities can also be structured as fixed or variable, which refers to the style of payments you receive:
- Fixed Annuities: Offer regular, guaranteed payments.
- Variable Annuities: Payments vary based on the performance of the annuity's investment options.
The appeal of adding an annuity to your retirement portfolio lies in its ability to provide a steady cash flow during retirement, offering peace of mind that you won't outlive your nest egg. Therefore, for the purposes of this explainer, we're going to focus on deferred annuities.
After you buy a deferred annuity contract, it enters the "accumulation phase." During this period, the annuity is funded, but has not yet begun to pay out, and your funds are growing on a tax-deferred basis (which means you won't have to pay taxes on any growth until you receive the payments). If you choose a fixed annuity, that money will grow at a guaranteed interest rate. If it's variable or indexed, the growth will depend on the performance of the underlying investments or index.
Your deferred annuity keeps growing until a certain amount of time has passed, which you choose when you purchase the annuity - generally 13 months to 40 years from the initial purchase.
Once the agreed amount of time has passed, your annuity enters the "annuitization phase," and your payouts begin. Depending on the terms of your contract, your annuity will continue making regular payments for either a specified amount of time, or until you die.
So, let's say a 30-year-old invests $65,000 in a deferred fixed annuity with a guaranteed interest rate of 5% per year. She's not planning on retiring until she's 65, so she picks a deferment period of 35 years. During that time, she's careful not to make any early withdrawals (which can result in penalties). After 35 years, her $65,000 annuity has grown to over $350,000. She opts for a life-only monthly payout plan and receives payments totaling around $2,000 that are taxed as ordinary income.
Now, this is just a hypothetical example to show how annuities grow and then pay out guaranteed income. The actual payout amount can vary significantly depending on many things, like the terms you choose, the state you live in, and the insurance company you purchase the annuity from. It's very important to discuss all of these factors and shop around for an annuity that meets your retirement income needs.
Also, when choosing the size of your annuity, remember that these are extremely illiquid funds with surrender periods and withdrawal penalties, so they're not ideal for anyone who may need access to their funds for unexpected expenses or emergencies. Due to the long-term nature of annuities, it's essential for you to carefully assess your financial situation and ensure you have other liquid assets available before committing to an annuity.
Adding an Annuity to Your Retirement Plan
In this thriving market for annuities, it's paramount for investors to prioritize quality.
You'll want to look for annuities underwritten by insurers with strong credit ratings to ensure financial stability. And remember, insurance companies are competing for your business, so you want to seek out the most competitive payouts, ensuring that your annuity choice translates to maximized income potential. However, even as annuities enjoy their moment in the sun, you'll still want to keep an eye on related fees and commissions to make sure they don't eat into your returns.
If an annuity seems like a good fit for your retirement goals, here's what you should do next:
1) Assess your financial situation. Determine your retirement income needs and how an annuity fits into that picture. (For example, maybe you want to use an annuity to guarantee you'll have enough income to pay your home and utility expenses.) This is an ideal time to consult with a financial advisor who specializes in retirement planning.
2) Choose the right type of annuity. Decide between fixed, variable, and indexed annuities, based on your risk tolerance and income goals.
3) Shop around. Compare offerings from different insurance companies to find the best rates and terms.
4) Understand the terms. Be clear on fees, surrender charges, and any riders that can modify the annuity's terms.
5) Make the purchase. Once you've selected an annuity, you'll go through an application process, which includes choosing your payment options and beneficiaries.
All in all, annuities can be a valuable part of a retirement plan, but they're not a one-size-fits-all solution. Balancing annuities with other retirement strategies, understanding the costs involved, and choosing the right time to buy can help ensure that this financial product meets your retirement needs effectively.
On the date of publication, Meredith Margrave did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
