Retirees often face a difficult challenge: turning accumulated savings into income that can last throughout retirement. Annuities are insurance contracts that may provide payments over a specified period or for the lifetime of an individual, depending on the contract.
They can play a role in retirement planning, but they are not simple savings accounts. Their costs, guarantees, restrictions, and insurer obligations deserve careful review.
What is an annuity?
An individual generally pays an insurance company either a lump sum or a series of payments in exchange for contractual benefits. Some annuities begin making income payments soon after purchase, while others allow money to accumulate before withdrawals or income payments begin.
An immediate annuity is designed to begin payments relatively soon after purchase. A deferred annuity generally begins its income phase at a later date.
Fixed and variable annuities
A fixed annuity provides interest or payments according to the contract's terms. The insurer's guarantees depend on its financial ability to meet its obligations.
A variable annuity allows the owner to allocate money among investment options. Its value can rise or fall with the performance of those investments. It may also include optional income or death-benefit features, often for additional charges.
An indexed annuity uses a formula linked to an external market index to determine interest credits, subject to contractual limits and rules. It does not necessarily invest directly in the index.
Understand the costs and restrictions
Annuities can include administrative fees, investment expenses, insurance charges, optional rider costs, and surrender charges for withdrawing money during a specified period.
Some contracts have complex provisions governing withdrawals, guaranteed payments, beneficiaries, and inflation adjustments. A payment that stays fixed may lose purchasing power as living costs rise.
Compare the insurer and the contract
Before purchasing, consumers should obtain the contract and relevant disclosure documents. They should understand what is guaranteed, what depends on investment performance, what happens after death, and what happens if they need access to the money early.
State insurance regulators oversee insurance products, while variable annuities also involve securities regulation. Buyers should check the professional's credentials and understand how the salesperson is compensated.
Bottom line: Annuities can provide structured retirement income, but the details vary widely. Compare guarantees, costs, liquidity, inflation exposure, and insurer strength before committing savings.
This article is for educational purposes and is not a recommendation to purchase an annuity.
