An annuity is a contract between you and a 3rd party (usually an insurance company) whereby in exchange for making a lump sum payment, the insurance company promises to do one, or some of these things:
There are only two types of annuities: Fixed and Variable.
Immediate annuities–start paying income right now (they start in less than one year)
Deferred annuities–start paying an income later
Multi Year Guarantee Annuities (MYGAS)–pay a fixed interest rate each year for a certain period
Indexed Annuities-increase in value depending on the performance of a baseline index like the S&P 500, Dow Jones, or another correlated index.
The key feature of fixed annuities is that the principal is FIXED–it is guaranteed by the insurance company. Gains are usually locked in each year, and you can mix and match different types of annuities to create a guaranteed income stream in retirement that is not influenced by interest rates, market fluctuations, or other typical market influences. These are good options for conservative individuals, and are not regulated as an investment, but an insurance only product. An agent only needs to be Life licensed to sell or offer a fixed, or indexed annuity.
With these types of annuities, the principal value varies based on the performance of the sub-account values where your money is allocated. These are viewed as investments and are sold by individuals that are licensed to sell both investments and annuities. (Financial Advisors) These are good for individuals that want upside appreciation, and can tolerate risk in their portfolio. This type of investment typically has higher fees and expenses because of the additional insurance costs that are prevalent because of the insurance component. Agents who sell these products must have their series license and work with a broker dealer. They are also subject to regulation by FINRA and the SEC.
The power of tax deferral and a triple compounding effect. Annuities pay interest on principal, interest on the interest earned, and interest on the taxes that would have been paid if it was in an investment that was being taxed annually.
It’s the only financial tool that can guarantee a lifetime income. Annuities can be part of a well-planned retirement because they offer the flexibility of access to cash without tax penalties after age 59 ½. Annuities might have certain advantages over traditional retirement plans because in the event of an emergency, an annuity allows access to some of the account value with penalty-free withdrawals.
They provide a pretty convenient and safe way to transfer wealth to heirs. Annuities avoid probate, which is extremely important. No one wants a court to decide who should receive their financial legacy.
When you cut through all the noisy articles that say annuities are not a good purchase, you’ll find that they can be very appropriate for many retirees.
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