When planning for retirement, there are myriad options for how to invest. The most common option is to use a retirement account — either a workplace plan like a 401(k) or one you get through a financial institution like an individual retirement account (IRA) — and to invest in various stocks, bonds and funds. While these investments are good at creating wealth, there is one thing they don’t do — create income that will help replace the income you’ll no longer have after you stop working. For that, you’ll likely want to look at a different choice — annuities.
And with interest rates high, annuities are particularly popular right now as investors look to lock in high rates of return on their annuity contracts.
Annuities can be a bit tricky, though, so you’ll want to take the time to educate yourself so that you make the right choices. You can also consider working with a vetted financial advisor who can guide you through how to work annuities into your plans.
What Is an Annuity?
Put simply, an annuity is a contract you enter into with an insurance company. Like with any other insurance policy, you’ll pay a premium up front in exchange for the promise of money paid to you down the line. Unlike with an auto or home insurance policy, though, collecting that money is not contingent on you having some sort of accident or incident; you are guaranteed a payout at a predetermined time.
The details of an annuity — your premium payments, how much you’ll get in retirement, how often you’ll receive dispersals and for how long — are all determined when you purchase the annuity. Again, make sure you take your time to get the best product for you. A financial advisor can help you make the right choices, but be careful if you are working with an advisor who is able to sell you the annuity contract himself. Such an advisor will likely earn a commission, and could be motivated to sell you a policy that isn’t the best one for you.
Fixed vs. Variable Annuities
There are many subtypes of annuities, but they fall into two main categories: fixed and variable annuities. Here’s what you need to know about both of them:
Fixed Annuity Basics
A fixed annuity is the most basic type you can purchase. There is a guaranteed interest rate and a set term over which you are paid dispersals once you reach retirement.
The upside of a fixed annuity is that you know exactly what you are getting. Your payments are not dependent on the whims of the market or any other outside force.
Within this category, there is a special type of annuity called an indexed annuity. This sees your premium payments invested in a stock market index. It is generally thought of as a way to combine a fixed annuity with a variable annuity (described below.)
Variable Annuity Basics
A variable annuity works similarly to a fixed annuity — you pay premiums in exchange for money later in life. The difference is that your money is invested in the market, often in bonds or stocks. The amount of money you get in dispersal payments is dependent on the performance of these investments — though you will generally be protected against losing your principal.
Should You Get an Annuity?
There is no simple answer to whether or not any individual should use an annuity as part of his or her retirement plan. Again, speaking with a financial advisor is the best way to figure out if that’s a good idea for you.
That said, one of the most basic questions to ask yourself about whether or not an annuity is right for you is whether or not having income in retirement is important to you. If you are confident in your ability to save money for retirement in a retirement account — and, even more importantly, confident in your ability to budget it effectively in retirement — an annuity may not be necessary. If, though, you want to have money coming into your account each month, an annuity could be a good option.
The Bottom Line
An annuity is a contract between a person and an insurance company. You agree to pay a premium upfront and in exchange you get payments in retirement. There are various types of annuities available, and a financial advisor can help you make the right choices for you.
- A financial advisor can make sure you are able to use annuities effectively. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Another insurance product you should consider as part of your financial plan is life insurance. This will help secure the future for your family if something were to happen to you.
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