What Are the Best Annuities for Your Retirement?

An annuity is a financial contract established with an insurance company, designed to provide a stream of income. Annuities involve an initial payment or series of payments made to the insurer in exchange for future regular disbursements. They help individuals manage the risk of outliving their savings, offering a predictable income stream for a specified period or for life. Selecting an annuity is subjective and depends on an individual’s financial situation and income goals. This article clarifies annuities to help readers make informed decisions for their financial future.

Understanding Annuity Types

Annuities come in several types, each with distinct characteristics regarding growth, risk exposure, and income predictability. Understanding these differences helps determine which annuity aligns with personal financial objectives. Each type serves needs for capital accumulation and income distribution.

Fixed annuities offer a guaranteed interest rate for a specified period, providing predictable growth and income payments. The insurance company assumes the investment risk, ensuring the contract value increases at a set rate regardless of market fluctuations. This predictability makes fixed annuities suitable for individuals seeking stability and a secure income stream, offering tax-deferred growth if held outside a qualified retirement plan.

Variable annuities, in contrast, allow the owner to invest in various sub-accounts, which are similar to mutual funds, offering potential for market-linked growth. The value of the annuity and the income payments can fluctuate based on the performance of these underlying investments. While variable annuities carry market risk, they also provide the potential for higher returns compared to fixed options, appealing to those comfortable with investment volatility.

Fixed Indexed Annuities (FIAs) combine elements of both fixed and variable annuities. Their returns are linked to a market index, offering growth potential without direct market exposure. These annuities provide some downside protection against market losses through a guaranteed minimum return, while capping or limiting participation in the index’s full gains. This structure balances growth potential with principal protection.

Immediate Annuities, also known as Single Premium Immediate Annuities (SPIAs), are purchased with a lump sum and begin providing regular income payments almost immediately. These are designed for individuals who need to convert a portion of their savings into a steady income stream. The payment amount is fixed at the outset, providing a reliable income flow for a lifetime or a specific period.

Deferred annuities allow money to grow tax-deferred over time before income payments begin at a later date, typically many years after the initial investment. This accumulation period enables the contract value to increase without immediate taxation on earnings, which can be advantageous for long-term retirement planning. Payments can commence at a chosen future date, providing flexibility for those who do not need immediate income.

Exploring Annuity Features and Riders

Annuity contracts can be customized with various features and riders that provide benefits or guarantees. These elements can influence an annuity’s suitability for an individual’s financial strategy, tailoring to specific needs. Understanding these components helps maximize the value an annuity provides.

Payout options

Payout options define how income payments are received from an annuity.

• A “single life” option provides payments for the lifetime of one individual.
• A “joint and survivor” option continues payments for the lives of two people.
• “Period certain” options guarantee payments for a set number of years, even if the annuitant passes away before the period ends, with beneficiaries receiving the remaining payments.
• A “lump sum” option allows for the entire contract value to be paid out at once.

Guaranteed Minimum Withdrawal Benefits (GMWBs)

Guaranteed Minimum Withdrawal Benefits (GMWBs) are riders that allow the annuity owner to withdraw a set percentage of their initial investment annually, regardless of market performance. This feature provides a predictable income stream while allowing the remaining contract value to potentially grow. Withdrawal percentages range from 5% to 10% of the benefit base, ensuring some access to funds even during market downturns.

Guaranteed Minimum Income Benefits (GMIBs)

Guaranteed Minimum Income Benefits (GMIBs) ensure a minimum income stream for life once annuitization begins, regardless of the underlying investment performance. This rider guarantees a minimum income base that can grow over time. The GMIB focuses on the income stream itself, offering a predetermined payout amount after a waiting period.

Death benefits

Death benefits specify what happens to the annuity’s value when the owner passes away. A standard death benefit might pay beneficiaries the contract’s current value or the total premiums paid, whichever is greater. Some enhanced death benefit riders, such as a “stepped-up” death benefit, can lock in the highest account value reached by the annuity on certain dates, potentially increasing the payout to beneficiaries.

Long-Term Care Riders

Long-Term Care Riders provide access to a portion of the annuity’s value to cover qualified long-term care expenses. These riders can help mitigate the financial burden of nursing home care, assisted living, or in-home care services. Funds accessed through these riders may reduce the annuity’s remaining cash value or future income payments.

Liquidity features

Liquidity features offer limited access to funds without incurring surrender charges. Many annuity contracts allow for penalty-free withdrawals of a certain percentage of the account value each year, commonly 10%. Some contracts may also waive surrender charges for specific life events, such as terminal illness, disability, or confinement to a nursing home.

Personal Factors for Annuity Selection

Selecting an annuity involves aligning the product’s characteristics with an individual’s financial situation and retirement objectives. There is no universally optimal annuity; the most suitable choice depends on a careful evaluation of personal considerations. Matching these factors to annuity types and features is a key step in the decision-making process.

Financial goals

Financial goals play a role in annuity selection. Individuals prioritizing guaranteed lifetime income might lean towards immediate or fixed annuities, which offer predictable payouts. Those seeking growth potential and comfortable with market fluctuations may find variable or fixed indexed annuities more appealing. Annuities can also serve purposes such as tax deferral for accumulated savings or legacy planning through death benefits for beneficiaries.

Risk tolerance

Risk tolerance is a determinant when choosing an annuity. Individuals with a low tolerance for investment risk prefer fixed annuities due to their guaranteed returns and principal protection. Conversely, those willing to accept higher risk for greater returns might consider variable annuities, which expose them to market volatility. Fixed indexed annuities offer a middle ground, providing some market participation with a degree of downside protection.

The time horizon for needing income

The time horizon for needing income is another consideration. If immediate income is required, an immediate annuity is appropriate, converting a lump sum into current payments. For individuals years away from retirement, a deferred annuity allows for tax-deferred growth over an extended period, with income payments commencing at a future date. This distinction influences how long funds remain in the accumulation phase.

Current income needs and future financial requirements

Current income needs and future financial requirements also guide annuity selection. Those already in retirement and seeking to supplement existing income sources may benefit from an immediate annuity. Younger individuals saving for retirement might use deferred annuities to accumulate wealth while working, then convert it into an income stream later. The flexibility of income commencement can be tailored to evolving needs.

Existing retirement accounts

Existing retirement accounts should be considered within the broader financial portfolio. An annuity can complement these accounts by providing a guaranteed income component, diversifying the overall retirement strategy. This helps ensure a balanced approach to retirement funding.

Health and longevity concerns

Health and longevity concerns can influence the choice of payout options and the inclusion of specific riders. Individuals concerned about outliving their savings may prioritize lifetime income options. Those anticipating potential long-term care needs might consider annuities with long-term care riders, which provide access to funds for such expenses. These personal health projections can shape the protective features.

Annuity Costs and Charges

Annuities, like other financial products, involve various fees and charges that can impact the net returns and overall value of the contract. Understanding these costs helps evaluate the expense of an annuity and compare different products. These charges compensate the insurance company for the guarantees and services provided.

Surrender charges

Surrender charges are penalties applied if funds are withdrawn from an annuity or the contract is terminated before a specified period, known as the surrender period. This period ranges from 7 to 10 years, with the charge starting at 7% to 10% in the first year and gradually declining to zero over the term. These charges help the insurance company recover expenses.

Mortality and Expense (M&E) fees

Mortality and Expense (M&E) fees are primarily associated with variable annuities. These annual charges compensate the insurance company for the insurance guarantees provided. M&E fees range from 0.5% to 1.5% of the account value annually.

Administrative fees

Administrative fees cover the costs of managing the annuity contract. These fees can be charged as a percentage of the contract value, between 0.1% and 0.5% annually, or as a flat annual fee ranging from $30 to $100. Some contracts may waive administrative fees for larger account balances.

Rider fees

Rider fees are additional costs for optional benefits added to the annuity contract. These riders come with their own annual charges. Rider fees range from 0.1% to 1.5% of the contract value or the benefit base, depending on the specific rider and the level of protection it offers.

Underlying fund expenses

Underlying fund expenses apply to variable annuities, which invest in sub-accounts. These are the expense ratios of the investment options within the annuity, covering management fees and operational costs. These expenses are deducted directly from the fund’s assets and can range from as low as 0.06% to over 3% annually, depending on the investment strategy.