What Is an Annuity?

An annuity is a financial product that you purchase from an insurance company, bank, mutual fund company, or brokerage firm. It can provide a steady stream of income, typically for retirement. There are different types of annuities, each with its own set of features and benefits.

Types of Annuities

Here are the three main types of annuities:

• Fixed Annuities: These offer fixed payments and a guaranteed rate of return. They are low-risk but may not keep pace with inflation.
• Variable Annuities: Your premiums are invested in assets like stocks, bonds, and mutual funds. Returns depend on investment performance, but you receive guaranteed minimum payments during the payout period.
• Indexed Annuities: These offer a guaranteed return and a return tied to a stock market index like the S&P 500. They are a cross between fixed and variable annuities.

Can You Lose Money in an Annuity?

While annuities are generally considered safe, there are risks involved. Fees can diminish your returns, and your money is not insured by the Federal Deposit Insurance Corp. (FDIC). It’s essential to weigh the pros and cons before investing in an annuity.

Benefits of Annuities

They Can Help You Save for Retirement

Annuities can provide a guaranteed stream of income in retirement, offering peace of mind if you’re worried about outliving your savings. They can be a part of a larger retirement savings plan, which may include:

• 401(k) or individual retirement account (IRA)
• Social Security benefits
• Brokerage account funds
• Permanent life insurance policy cash value
• Pensions, if applicable

They Can Provide Diversification

Diversification is crucial in investing to spread out risk. Including annuities in your financial portfolio can help diversify your retirement income.

Some Annuities Provide a Death Benefit

Certain annuities have a death benefit provision, allowing you to leave a portion of your annuity payment to a beneficiary. Couples can opt for a joint-life annuity, which provides higher payments when both are alive and reduced payments for the survivor.

Risks of Annuities

Fees

Annuities can come with various fees, including:

• Agent commissions
• Administrative fees
• Surrender penalties
• Early withdrawal fees
• Mutual fund fees
• Mortality and expense risk fees

Returns May Lag Behind Other Investments

Annuities are low-risk, but their returns may not be as high as other investments. Fixed annuities provide a guaranteed return that may not keep up with inflation.

Annuities Are Not FDIC-Insured

Annuities are insured by state guaranty associations, not the FDIC. Coverage levels vary by state, so it’s essential to check with your state’s guaranty association for details.

Should You Buy an Annuity?

Whether an annuity is right for you depends on your financial situation and long-term goals. Annuities might be suitable if you want to:

• Secure guaranteed income payments in retirement
• Expand your investment portfolio
• Leave a death benefit to a beneficiary
• Diversify your retirement income
• Find a low-risk investment

However, keep in mind that annuities come with fees, and returns may lag behind higher-risk investments.

What Is Better Than an Annuity for Retirement?

Some retirement accounts offer tax benefits and may be better alternatives to annuities, including:

• 401(k): Employer-sponsored retirement plan with pretax contributions and tax-deferred growth.
• Traditional IRA: Individual retirement account with potential tax deductions on contributions.
• Roth IRA: Funded with after-tax dollars, offering tax-free withdrawals in retirement.

The Bottom Line

Annuities can be a valuable part of your long-term financial plan, especially if you want guaranteed income in retirement. However, it’s essential to consider the potential downsides, such as fees and lower returns compared to other investments. Using annuities alongside other retirement savings accounts can be a good strategy.

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