Annuities are basically nifty instruments that provide you with a steady stream of income until you pass away. Simple? Let me stop you right there. The subject of annuities in its entirety is far more than that. There are various types, and payouts are affected by a myriad of externalities such as interest rates, age of annuitant etc. Before I bore you to death, let's answer the fundamental question: Should you consider annuities as a viable option in retirement?
Annuities: Yay or Nay?
There is much to like about annuities. Firstly, they offer a guaranteed income from the time payouts start until the annuitant's passing. Of course, the amount guaranteed will depend on the terms and conditions of each insurer, and would vary widely across the board, but who says no to guaranteed income?
Annuities also offer some tax deferral options which is not available to other investment vehicles. In fact, they are the only one to do so. Capital invested in annuities of all kinds can be allowed to flourish while remaining tax-deferred until the time that it is decumulated. This presents a clear advantage when compared to IRAs and is an interesting and viable option for the rich looking to store huge amounts of capital in alternative investments.
Creditors also have limited access to income derived from annuities. Once again, this differs between states (so it would be best to examine the fine print), but it's always an advantage to be able to rely on some protection from creditors, especially in financially turbulent times.
But of course, there is no such thing as a free lunch, and annuities have their share of downsides. Firstly, annuity payouts are intrinsically determined by the underlying interest rates paid on them. In periods of low interest rates, this could place downward pressure on payouts, increasing their volatility. This could spell trouble for retired annuitants, who could be heavily reliant on their annuity payouts for daily living.
Another commonly cited downside of annuities is their lack of liquidity compared to other investment vehicles such as stocks or bonds. Annuities are almost impossible to transfer, and to exit from an annuity's contractual agreement entails severe exit costs or penalties due to actuarial factors. As such, annuities appeal more to those looking for long-term investment rather than a more time-limited horizon, which also explains their relative unpopularity.
Lastly, annuities are complex instruments, and difficult to understand for those who lack the relevant financial background. Without adequate education from insurers to their clients, retirees could end up investing in an instrument that they are not fully aware of, which can be dangerous.
What to look out for when purchasing annuities
As with any investment, sensible investors must seek to find out everything they can before committing their capital. Some of the important points to look out for when it come to annuities include:
Withdrawal conditions: Annuitants must be fully aware under what kind of circumstances are they allowed to make full or partial withdrawals, as well as the accompanying penalties involved if any.
Reliability of the insurance company: Annuities are only useful if they provide a guaranteed stream of income to those who purchase them. And these payouts are only as reliable as the companies providing them. Always make sure that annuities purchased are from reliable insurers who can fulfil promises made to their clients.
Investment expenses: As with any investment, expenses can eat into the capital gains or upside received by the investor. The same applies to annuitants, who need to choose wisely between various insurers to ensure that they are getting a value-for-money deal rather than getting ripped off.
Bequest feature: Annuities are essentially all about risk-pooling, so always ensure that you are fully cognizant of the bequest feature of the particular annuity product before purchasing. Some annuities do not provide a bequest feature, which essentially means that you lose any capital invested should you pass away early.
Annuities may not be the optimal investment for everyone, so make sure that you cover all angles and have confirmed that annuities are indeed suitable for you before signing on the dotted line. Hope you enjoyed the read!