“Annuity” now there is a word that generates some mixed feelings, and along with those feelings a myriad of conflicting opinions, both personal and professional. How can someone possibly determine if annuities are a useful financial tool for them? The answer to that question is simply to be educated. Below are some key points you should know if you’re considering using an annuity in your financial plan.
Types of Annuities
Annuities can be used for either of the two phases of retirement planning: accumulation or distribution. Depending on which phase you are in, you may decide on an immediate or deferred annuity. Immediate annuities are for the distribution phase where you exchange a lump sum for a guaranteed monthly income. Deferred annuities are for accumulation and are intended to grow until you are ready to begin distributions. If you are still in the accumulation phase you need to decide if you want a fixed or variable annuity? Fixed annuities work a lot like a Certificate of Deposit where your investment earns an agreed-upon interest rate for a pre-determined period of time. Variable annuities are typically invested in securities and fluctuate in value depending on market conditions.
Every financial adviser is compensated to do their job. One way that many financial professionals are compensated is in the form of a commission and annuities are one type of investment that pays a commission. This can be seen as a conflict of interest for many investors so it is important to trust your finances with a licensed professional who is acting in a fiduciary capacity, which means they are acting in your best interest. You can reference https://brokercheck.finra.org to verify your financial adviser’s credentials.
Charges and Fees
In addition to disclosing how they are paid, your financial adviser should also be open about the administrative charges and potential fees that your investment may entail. This is one area where annuities are commonly misunderstood and this has caused some investors to have concerns about overusing them. Being that annuities are designed to be long-term investments, there are some liquidity restrictions to getting to your money. You may incur a “surrender fee” for taking distributions from the account prematurely, so you will want to be sure that you have enough liquid assets to support your expenses before investing in an annuity. Annuities also, like most other investments, carry an administrative cost. This is often referred to as a mortality and expense charge and is in place to cover the expenses of the institution. Things like account reporting, support staff, commissions for the selling agent, and overhead costs are just a few of the items that may be covered by the M&E charge.
Benefits to Purchasing an Annuity
Annuities are typically an insurance product and because of that many carry some very unique and valuable benefits. Some immediate annuities are a type of insurance that can help protect you from outliving your assets. These investments can generate a stream of income for the life of the annuitant much like a pension and are guaranteed by the issuing company. Non-qualified deferred annuities grow on a tax-deferred basis, meaning you don’t pay taxes on the growth of your investment until you begin to take distributions. Deferring taxes is a potential way to help your investments grow at a faster pace and possibly reduce your tax liability. In addition to guaranteed income and tax-deferred growth, most annuities also have a guaranteed minimum death benefit (GMDB). The GMDB is a way of protecting your principal investment regardless of the market performance of your account.
Are Annuities Good or Bad?
Annuities are often misunderstood and as a result, they tend to get a bad rap. However, like most things, the truth is not so clear-cut. When used properly, an annuity can be an incredibly useful tool in an investor's overall financial plan. Working with a qualified financial adviser and having a better understanding are a few ways that you can ensure purchasing an annuity is the right move for you.
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Written by Justin Meyer