Understanding Annuities and Choosing Your Best Option

Posted by Bill Bruce on Feb 2, 2023 11:00:00 AM

AdobeStock_184941374Most of us remember our first paycheck. Most of us held it in our hands, feeling excited, happy, and possibly proud of the work we’d done to earn it. What we likely didn’t think about was a lifetime of paychecks ahead of us and how it would make us feel when those paychecks stopped. For many starting to consider retirement, the reality of post-retirement income or lack of it, can be a scary thought. Thankfully, it’s the very reason annuities exist.

Still, understanding what annuities are as well as what they can do for you can be overwhelming. That doesn’t mean they aren’t a great option. In fact, for a lot of folks annuities are the perfect option, they just have to choose the one that’s right for them.

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What are Annuities?

Annuities are a financial product to help provide an income stream for a set period of time, typically retirement. Annuities allow individuals to benefit from the security of regular payments, which can help protect against the risk of outliving one's savings while also providing potential growth opportunities. 

How Do Annuities Work?

After an individual purchases their annuity, with either a lump sum or a series of payments, the funds are invested to either maintain or grow the funds, depending on the buyer’s preference. Then, later in life, when you need the funds and regular income, typically once an individual has retired, the funds are distributed as monthly payments

For those looking for retirement income with long-term security and potential growth opportunities, an annuity might be the right choice; however, it’s important to consider all the factors involved before deciding which type is best for you.

AdobeStock_85633978What are the Different Types of Annuities?

Annuities may be purchased with a single lump sum (single premium) or through periodic contributions over time (flexible premium), and come in two primary forms: fixed and variable. 

Because annuity funds are typically invested in stocks, bonds, or money market funds, buyers are able to determine their risk tolerance. For more risk averse individuals, fixed annuities protect purchasers from market fluctuations; their rate of return is guaranteed by the issuer regardless of outside economic conditions. In contrast, variable annuities come with more risk but potentially more reward as they are subject to market fluctuations; these annuities may include investments within stock, bond, or money market funds.

In addition to variable and fixed annuities, there are a few other options to be aware of including immediate and deferred annuities.

Immediate annuities- An immediate annuity, by any other name, such as single premium immediate annuity, still functions the same. These annuities typically begin their payouts within a year of initial purchase. This allows purchasers to turn a more traditional retirement account into a steady, monthly, income stream.

Deferred annuities- In contrast to immediate annuities, deferred annuities do not begin payouts immediately and are typically held until later in life. The goal with a deferred annuity is that it provides the opportunity to let funds grow before payouts begin. Further, these annuities are also tax-deferred which means they are allowed to grow, tax-free, until withdrawals begin.

Deferred annuities are available as either fixed or variable, as discussed above. However, there are also indexed annuities which have no investments. Instead, their growth is tied to an outside index, such as the S&P 500 and often have limitations such as participation rates, interest rate caps, and yield spreads. These are, typically, more complex than standard annuities and can be volatile depending on the index.

Medicaid compliant annuities- Medicaid compliant annuities are single premium immediate annuities that allow purchasers to benefit from medicaid support when it comes to needing and paying for an assisted living or skilled nursing environment. Instead of traditional medicaid pay downs that create eligibility, a spouse or individual can still qualify for medicaid but also receive a monthly stream of income from the annuity. 

Additional Annuity Factors to Consider

While understanding the types of annuities is important, one of the other big factors you’ll want to understand is how the payouts work. Traditionally, while the monthly payouts are higher than what are considered “safer” vehicles like certificates of deposit (CDs), they’re not as high as riskier investments like the stock market; however, they are consistent.

Further, annuity payout benefits may also be dependent on several other factors including:

  • Demographics like your gender and age when you start receiving benefits
  • The type of annuity and any attached riders that may guarantee or boost payouts
  • The number of individuals on a specific annuity (shared holders)
  • Serious health issues
  • Market conditions (especially for variable and indexed annuities)

AdobeStock_442307308How Do I Know Which Annuity is Right for Me?

Choosing the right financial retirement options can be a daunting task. Annuities can be an amazing strategy or part of a larger strategy, but knowing what to choose can be difficult. In addition to talking to a professional, you’ll want to consider a few things to help you make your selection and it’s wise to have these thoughts gathered prior to meeting with a professional. While they will understand the annuity options out there, you’ll be the best person to champion your goals and needs.

  1. What are your monthly expenses? What expenses will you continue to have through retirement? What expenses might you incur during retirement that you do not have currently?
  2. What sources of income do you have or will you have in retirement? Include anticipated social security payments, pensions, and other investments.
  3. Are there any additional valuable assets?
  4. When do you hope to retire?
  5. Do you have any major health concerns or family history of health issues? 
  6. Based on question 3, how long do you need to sustain the expenses in question 1?
  7. Do you anticipate you, a spouse, or partner requiring a long term care facility?
  8. Do you have other dependents? Do you anticipate leaving money for them? If so, how much?
  9. How would you describe your health? Your spouse’s health?
  10. How do you feel about financial risks?

Planning for later in life isn’t always easy, but planning ahead is still your best option. Having considered all of these things, and perhaps done a little research on your own, it’s time to contact a professional who can not only help you make a solid plan, but also help you find the annuity that’s right for you.

If you’d like to discuss your options, let us connect you with an ELCO Mutual independent insurance agent and get you started on the path to security.
Enjoy financial security when you retire CTA