An annuity is an insurance investment that provides a stable and reliable income stream during retirement. It is essentially a contract between an individual and an insurance company stating the insurance company will return the original investment plus interest at a later date in fixed installments.
The person purchasing the annuity, known as the annuitant, either purchases an annuity with a lump sum or makes monthly payments. This phase is called the accumulation phase.
During the accumulation phase, your annuity begins to earn tax-deferred interest via the investments the insurance company has purchased using your premium(s). The kinds of investments they buy depend on the annuity, ranging from more aggressive to more conservative.
Of course, there is always Social Security (if it doesn’t run out), but most individuals would prefer a lifestyle more lavish than that which Social Security can provide on its own.
Annuities fill that gap between potential portfolio failure and a reduced lifestyle that Social Security would provide. It is, in essence, insurance against the financial markets. And if your portfolio performs as planned, congratulations! An annuity will only enhance your retirement experience.
There are several different types of annuities to consider, including fixed, variable, and indexed.
Fixed annuities provide a guaranteed rate of return because the premiums you give to the insurance company are, in turn, invested into fixed-income securities, such as federal, municipal, and corporate bonds. These bonds or other debt securities are chosen for their stability and risk aversiveness.
The upshot is that you’ll receive your income regardless of how the markets are doing.
Variable Annuities invest in more aggressive mutual funds that consist of a mixture of stocks, bonds, and money market instruments. Accordingly, the performance of a Variable Annuity is quite variable, as it has a higher exposure to the whims of the market compared to a Fixed Annuity.
The reasoning, however, is simple. The investor is pushing the responsibility of volatility and loss onto the insurance company. That doesn’t come for free!
An index annuity invests in an industry benchmark consisting of a wide range of stocks that meet benchmark criteria. The S&P500 is the most popular benchmark. Stock market indexes offer more stability than individual stocks or actively managed mutual funds, but the profits are limited. Funds are spread thin through various companies so that, even if one fails, you don’t lose everything. If one company’s stock soars, you don’t have enough money invested in that company to exactly strike it right.
An index fund wrapped inside an annuity provides further stability and protection, with less chance of loss but less upside as a result. Again, the payoff is that the payment is guaranteed, though at a lesser payout than investing in the S&P 500 would alone.
Additionally, they are not FDIC-insured. If the insurance company files for bankruptcy, the state will step in and attempt to salvage annuities by transferring them to another insurance company or, if that fails, move them into the State Guaranty Fund. Limits do apply, however, and they may not cover variable annuities.
At Walters Strategic Advisors, we possess the requisite knowledge and experience to guide you through the whole process and help you determine if an annuity is right for you.