Are you fearful of an impending recession? You’re not alone. But that shouldn’t prevent you from reaching your retirement goals. While retirees and those nearing retirement have less time to ride out stock market volatility, inflation, rising interest rates and a possible recession, there are steps you can take to safeguard your savings and soften the blow. So, how do you move forward amid so much uncertainty? June is National Annuity Awareness Month, designated to help educate Americans on the importance of annuities as part of a secure retirement savings plan.
What is an annuity?
An annuity could be thought of as a self-funded pension. Rather than your company paying into a retirement savings vehicle, you are funding the investment. Typically, this is a contract between you and an insurance company. You contribute funds to the annuity, and in exchange, the insurance company promises to pay you a certain amount of money, generally monthly, for the rest of your life. Those nearing retirement contribute money to the annuity in exchange for guaranteed retirement income.
What are the types of annuities?
There are many types of annuities. They’re like Baskin-Robbins; they come in all kinds of flavors. Some have market risk, others come with high fees. Some have low fees and there are even a few with no fees. Some credit a fixed amount of interest and others provide a variable rate based on the performance of an index.
There are two basic types of annuities: deferred and immediate, and they can be structured as either fixed or variable.
Immediate Annuities
An immediate annuity starts paying its buyer soon after the initial investment. It’s common to see people purchase an immediate annuity right before retirement to start generating consistent income when they stop working. This type of annuity is a good option if you suddenly come into a large amount of money like winning the lottery and receiving a stream of payments. With an immediate annuity, you can specify a fixed or variable payout that will not change for the rest of your life. An immediate annuity can turn that initial investment into guaranteed lifetime income.
Deferred Annuities
A deferred annuity accumulates your money until you begin to take withdrawals, usually in retirement. These are similar to other retirement accounts in the sense that you can contribute to a deferred annuity throughout your working years. Regular contributions are tax-deferred, meaning you won’t pay taxes on your contributions as they go in, but you will pay taxes when you start to withdraw from the annuity. Some retirees fall into a lower tax bracket during their golden years, and deferred annuities could potentially help lower their taxes.
Fixed Annuities
Fixed annuities provide guaranteed streams of income based on a minimum interest rate. This type of annuity is normally a much safer investment because the value never goes down due to market conditions. Insurance companies take the premium you pay upfront, and after a set period of time, begin paying you the money agreed upon in the contract. These annuities accumulate on a tax-deferred basis, meaning you don’t pay taxes until you withdraw your earnings or trigger a guaranteed income for life. It’s similar to a company’s pension plan—but the difference is that it’s you, not an employer, whose contribution makes those lifelong, valuable payments possible. People who want guaranteed rates of return and don’t want to risk their principal due to market conditions should consider these annuities. There are no surprises. Remember you only want surprises on your birthday!
Variable Annuities
Variable annuities are an alternative to fixed annuities—and often the riskier route to take. They tend to come with high fees. Similar to fixed annuities, variable annuities are tax-deferred. What makes them variable is the opportunity to earn higher rates of return by investing in equity or bond subaccounts. If you choose wisely, the value of your annuity can grow. On the flip side, of course, you could lose money—including your principal amount—if the allocations lose value.
How do I know if an annuity is right for me?
The first thing you need to understand is an annuity can be a medium or long-term investment with provisions requiring accumulation for a set number of years. Investors will be penalized if they withdraw before age 59 ½. For this reason, if you’re under the age of 50, investing in an annuity may not be for you. Don’t put yourself in the penalty box! If you’re someone who requires 100% liquidity upfront or if you expect to earn 8-10% per year, that’s just not in the cards with an annuity.
Candidates for an annuity include those who want guaranteed income for life and those who need peace of mind. An annuity is a great option for those who want to capture the ups of the market but never the downs. Annuities can be complicated! There are so many different terms within an annuity that investors may not understand what they are signing up for. Do your research and talk to someone you trust.
Once you become educated, annuities can play a vital role in the retirement planning process. Annuities offer guaranteed death benefits and payment options to help meet retirement income needs. As always, the devil is in the details. Visit a trusted financial advisor to learn how an annuity or lifetime income option can work for you. What’s right for one person might not be right for you. If you have questions about the different types of annuities or what to consider, send us a message or give us a call at 860-676-1100.
Roger Cowen is the founder and president of Cowen Tax Advisory Group.
Founded in 1978, Cowen Tax Advisory Group is a family-owned financial planning firm located in West Hartford, Connecticut, with over 130 years of experience in the financial industry.
Investment Advisory Services are offered through SGL Financial, LLC, a Registered Investment Adviser. Insurance and other financial products are offered separately through individually licensed and appointed insurance agents.
