In this blog post, Eric discusses annuities basics and most frequently asked questions. She delves into the advantages of annuities, as well its disadvantages. Additionally, she describes the five types of annuities that you may come across.
What are annuities?
When a person invests in an annuity, that person is setting the stage to receive income in the future, with a set date and conditions. It is usually part of a retirement strategy and it is a popular choice for investors who want to receive a steady income for retirement.
How do annuities work?
Annuities are a long-term plan made by the insurance company that fits the needs of an elderly customer. It is to help protect the customer from the risk of overspending and not saving for the future by creating a lifetime income..
What are the advantages of annuities?
First, there are tax benefits. They allow the investor to stock away a larger amount of cash and defer paying taxes on the receipt of that cash. Annuities allow the investment to be put away for a future purpose, such as retirement. The money that the investor invests compounds year after year without tax consequences, and at times, when it’s a qualified plan such as a Roth IRA or a Traditional IRA, every dollar of the investment gain is tax-free or tax-deferred, respectively.
What are disadvantages of annuities?
- Annuities may sound great for investor to save money for the future. However, there are high investment fees that cut into your profit margins, especially on variable annuities, so the buyer should be careful.
- Annuities also have punitive surrender charges. This means, for 7 to 10 years, your money is locked up with penalties if you withdraw it early.
- Insurance brokers earn commissions so at times, they would try to sell the highest costs to the buyer, to maximize those commissions.
Are there different types of annuities?
Five Basic of Annuities
Multi-Year Guarantee Annuities (MYGA) is a part of a fixed annuity that has an interest rate guarantee for some period of time. MYGA year periods come in 3 year, 5 year, 7 year, 10 year, and 15 year periods, where the average fixed return percent is 2 to 3%. The multi-year guarantee annuities are different from fixed index annuities.
Fixed index annuities usually are tied to the market, but with a floor of 0 percent, which means that even if the market were to crash, you would not lose any part of your principal. If the market does well, you will have a “cap”, so if the market does extremely well, you will not be making as much as if you went into a variable annuity. Fixed-indexed annuities have a contract value and many times, a guaranteed minimum income benefit as the client has a chance of principal upside linked to the market index.
This is when the buyer opens up an account with funds typically earmarked for their retirement, and they want market exposure. The account value can grow or shrink depending on the customer’s choice of the investments. The insurance company provides insurance on the investment in the event that the market performances is poor, such as having a lifetime income amount that is not threatened by any loss of principal.
Immediate annuities are when the investor gives the insurer a lump sum in return for regular income payments until death or for a certain guaranteed time period, such as 20 years. The lump sum for an immediate is usually higher than other annuities because it include principal, and interest and tax. So a $2,000 drop in will get you very little. However, a $200,000 drop in can get you a nice fixed monthly income. An immediate annuity allows the client to create a pension that is based on the buyer’s goal of a fixed income payment that is stable for the rest of their lives or at least, for a certain time period.
Deferred annuities are delayed payments until a future date. It give the buyer the opportunity to increase their income stream for the future, while putting away something now that will earn them credits towards a higher lump sum or lifetime income benefit years down the line, such as in 10 years. The deferred annuities also have lower costs, and is a good way for an investor in their 50’s with lots of cash to start saving for retirement, which is about 10 years away, at that point.
If you would like to learn more about annuities basics, the types of annuities, or see what Mangus Finance has to offer you, please click here.
Erin Bui is the Mangus Finance Circles specialist based in Riverside, CA, focused on helping special needs and senior communities with financial education and awareness.