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What are annuities? How do annuities work?One of the biggest financial worries most people have is providing for a comfortable retirement. After a life of hard work, the thought of poverty in our old age terrifies most of us. But with the days of pensions and retirement funds long a thing of the past for most of us, we are left with only a few options when it comes to providing income during retirement. Sure, there are still some of us that can rely on pensions from government or military jobs, but if you are under the age of 50, chances are Social Security will be your old steady monthly check once you retire, and not a very big check at that (assuming Social Security survives, we've all heard the stories of the dwindling surplus and possible reduced future benefits). 401Ks are the biggest retirement savings vehicles today, but those don't generate specific levels of income -- instead they are invested in the stock market (normally) and you withdraw a portion of the capital each year to live off. You can also put savings into stocks and bonds that pay regular interest and dividends. But what if you want a steady stream of income for the rest of your life, even if you live to be 110 years old (since your 401K may be long empty by then..)? What if you just sleep better at night knowing your money is income is not tied to the gyrations of the stock market? If so, you might want to consider investing in annuities.
Different Types of Annuities - Variable Income Annuities, Deferred Variable, Fixed Income Annuities, Deferred FixedMost people that invest some portion of their assets into annuities do so to guarantee some base level of income that will last them throughout their retirement years, even if they live to be 100 years old. But you need to know what type of annuity to choose, since there are a number of varieties, all with different features and expenses involved. Let's start with variable income annuities. About 5% of annuities sold last year were variable income annuities. The "variable" part of the name means the income you receive from them varies according to how the stock market does, so they offer some protection from inflation. Most of us don't think much about inflation, but while getting a fixed $1500 a month check might sound great today, what if food costs keep going up 5% per year? Twenty years from now, that $1500 might not buy you much to eat -- so having a variable check that goes up as inflation and the stock market goes up might make a big difference to your financial well being. You buy a variable income annuity (VIA) by paying an upfront lump sum - $50K or $100K or whatever it is you want to invest. Most VIAs start paying you a monthly benefit immediately and last throughout your lifetime. Most VIAs also offer a death benefit, which will pay your beneficiary some portion of the difference between what you have invested and what you have received in income. Taking money back out of a variable income annuity can be difficult and costly, though. Most VIAs charge a surrender charge if you take money out during the first few year, which can amount to up to 7-10% of the amount withdrawn. On top of sales commissions and expenses, you could lose more than 10% of your investment in just a year if you need to take the money back out after buying a VIA, and you may have to pay additional federal tax penalties. So that may be the most important thing to remember when considering variable income annuities -- these are meant to be long-term investments, not places to park money for a few years and then take it back out. We suggest you review the detailed variable annuity guide that the SEC publishes for more details and warnings.
Deferred Variable Annuities allow you to contribute money into the policy over time, allowing it to grow tax-deferred until you begin taking withdrawls, which is normally at age 59 1/2 or greater. Again, there are annual administration fees and surrender charges associated with these vehicles, so you'll need to do your research and read the fine print when dealing with your insurance agent or broker. And your money is essentially locked up for a long period of time -- don't plan on taking your money back out the next year. These variables again offer performance linked to stock market returns, so future payouts are not a fixed amount. Most people invest in other retirement vehicles like IRAs before moving into something like deferred variable annuities -- check with your financial advisor before making any investments. Fixed AnnuitiesWith fixed annuities, you are "fixing" or locking in your rate of return for a certain period of time. They can be immediate fixed annuities or deferred, just like the variable ones mentioned above. With immediate fixed annuities, you make a lump sum purchase and begin getting monthly payments that last your lifetime. Since the payout is based on your life expectancy, you will get less per month if you buy an annuity at a younger age (like 60) than an older age (70). Keep in mind that your monthly or annual payout will be the same throughout the life of the annuity (remember the inflation talk above?). The deferred fixed annuities come with similar tax benefits to the variable ones, namely your payouts are not taxed until you begin receiving them.Annuity WarningsSince there has been so much abuse in terms of fees and commissions when it comes to selling annuities, there is usually a 10 day grace period in most states during which you can back out of an annuity sales contract. Confirm with your broker or agent that the annuity you are buying comes with a "free-look" period. Also, as mentioned above, you are going to want written explanation of all fees and surrender charges. Most salespeople won't tell you how much commission they are making off your sale, but it is usually substantial -- that is why there is such a push into these investments. But you should know all the other fees - annual management fees, early withdrawal penalties, surrender percentages by year (ie, how much first year, how much in second year, etc.). Watch out for extra "options" that are tacked onto your annuity. Some of them might sound appealing, but each one adds onto the cost you will pay. Make sure you do your part by getting quotes from several different insurance companies or mutual fund companies when it comes to buying an annuity -- rates of return, expenses, and fees vary from company to company, so make sure you are getting a fair deal by comparing.Annuity Calculator - Annuity Prices and QuotesTo get an idea of the kind of payouts you can get from an annuity, check out the annuity calculator at ImmediateAnnuities.com. Punch in your age and how much you want to invest or receive in income, and it will calculate the rest. They can link you directly to annuity quotes from a lot of insurance and financial companies, like Allianz, American General, EquiTrust, Genworth Life Insurance , MetLife, New York Life, Penn Mutual, United of Omaha, ING USA Annuity & LIC, Integrity, and more. MoneyChimp.com also offers a simple pop-up annuity calculator here.
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