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Is An Annuity Right For You?

annuity worth

Let’s be completely transparent here. Not everyone needs an annuity. If you can cover all of your expenses in retirement via Social Security, your pension, or other retirement assets, then it’s not worth buying an annuity.

The same is true if you’re not in the best of health since you may not outlive this steady lifetime income stream. Also, if you’re looking for higher risks in your investments, then you have better alternatives. These can include high yield bonds or real estate investment trusts (REITs).

But, if you want to diversify your retirement portfolio, are in good health, and want a way to have a monthly income during retirement, annuities might be an option.

That’s just scratching the surface though. And, to be honest, this might not be enough to go on to make this important financial decision. With that in mind, this chapter focuses on deciding wheter an annuity is or isn’t right for you. 

You’ve Maxed Out Your 401(k) Plan

“If you’ve already reached your 401(k) contributions limit for the year—or soon will—that’s a problem,” writes Kimberly Rotter for Investopedia. “You can’t afford to fall behind in the funding-retirement game.” What’s more, “losing the contribution’s reduction in your gross income isn’t going to help your tax bill next year.” 

So, what can you do if you’ve maxed out your 401(k)? Here are the next steps to take next. 

“Maxing out a retirement account contribution means that you’ve contributed or deposited the maximum amount that’s allowed to an individual retirement account (IRA) or a defined contribution plan, such as a 401(k),” explains Rotter. “If you’re under the age of 50, the maximum amount that you can contribute to a 401(k) is $19,500 for both 2020 and 2021.” 

If you’re 50 or older there’s good news. You’re allowed to add more money to your account. This is called “a catch-up contribution, which amounts to $6,500 for 2020 and 2021.” That means, “if you’re 50 or older, your maximum, annual limit for total 401(k) contributions is $26,000.”

Your first option should be an IRA. Both a traditional and Roth IRA are tax-deferred. But, there are also contribution limits. According to the IRS, “For 2021, 2020, and 2019, the total contributions you make each year to all of your traditional IRAs  and Roth IRAs can’t be more than:

  • $6,000 ($7,000 if you’re age 50 or older), or
  • If less, your taxable compensation for the year”

To sum up, it’s strongly suggested that you only buy annuities after you’ve addressed the following retirement fund investments (in the following order):

If you have, then it’s worth exploring an annuity. 

Review the Advantages and Disadvantages

An annuity isn’t your only option after you’ve maxed out your 401(k), traditional IRA, or Roth IRA. If you have a low-risk tolerance, you might want to invest in municipal bonds. If you have a higher risk tolerance or the money, you could invest in variable universal life insurance or real estate. 

Moreover, you also need to weigh the pros and cons of an annuity. We’ve already covered this in a previous chapter. But, here’s a refresher. 

The advantages of an annuity. 

  • A guaranteed lifetime payout option. This means that you can’t outlive the money in your annuity account. Even better, it doesn’t matter how long you live or the performance of the stock market.
  • Your investment is protected. Unlike other investment options, annuities provide principal protection. It’s also protected from potential dangers, like losing your money to fraud, unscrupulous advisors, and poor investment decisions.
  • Payments are usually higher than other low-risk investments. You’ll get more bang for your buck with an annuity than low-risk investments like certificates of deposit, bonds, or money market accounts.
  • Annuities allow room for more risk. If an annuity is able to cover your basic living expenses, any additional money you have can be put towards riskier investments that could yield better returns.
  • Annuities are safe. While annuities are not FDIC-insured, state guaranty associations protect annuities against insurer insolvency. Just note that this is only up to certain limits. Generally,  $100,000 to $300,000 per annuity owner.

The disadvantages of Annuities 

  • There’s a minimum investment amount. For most annuities, a relatively large sum of money is needed to get started. While not the case for all annuities, this could range anywhere from $2,500 to $25,000. You also need a large sum of money to make an annuity worth the investment. Typically,  this is $100,000 for a $500 monthly payment that would start at age 65.
  • You have to commit the money upfront. To purchase an annuity, you need to pay for it in advance with a lump sum payment. However, a deferred annuity could allow you to make installments.
  • Annuities aren’t liquid. While you can make withdrawals, you may have to pay surrender charges. If this is prior to age 59 ½, you’ll also have to pay the IRS a 10% penalty fee. Even if the annuity company permits early withdrawals, it’s only up to a certain percentage, usually 10% of the annuities value. 
  • Payments stop when you die. If you have a spouse or heirs that may not be able to receive the remaining value of your annuity. Some annuities do allow you to add a death benefit rider. But, you will have to pay extra for this. 
  • Interest rates are potentially low. This ultimately depends on the annuity you chose and when. A fixed annuity provides predictability, but the interest rate could be lower than other investments. If you select a multi-year guaranteed annuity or MYGA, the guaranteed fixed interest rate is only for a certain period.
  • You need to work with a financially strong company. Regardless if it’s an insurance or annuity company, you need to make sure that they’re financially stable. If not, you may lose everything if the company goes under. 

Is an Annuity Right for You?

If you’re still on the fence, answer the following questions to make sure an annuity is right for you.

How will an annuity work with my other income?

“When considering annuities and whether a particular type of annuity fits your needs, do so in the context of all your retirement income, savings, investments, and assets, and determine which purpose each income stream will serve,” the folks over at Charles Schwab. “You’ll probably already have one form of income—monthly payments from either Social Security or a government pension—and that might be enough to satisfy your need for lifetime guaranteed income.”

“But if you’re concerned about outliving your savings and want a higher level of guaranteed income that doesn’t depend on markets, one strategy might be to allocate a portion of your retirement savings to a fixed income annuity and invest the rest in a portfolio of investments,” they add. “A combination of annuity payouts and portfolio can be particularly helpful if what you receive from Social Security or a pension doesn’t meet your financial needs.”

You could also consider a deferred annuity. This type of annuity pays later in life. And, it requires a smaller investment that can be made through a series of payments. It’s an option if you’re worried that other retirement vehicles, like Social Security, will run dry. 

What’s your age?

It’s possible to buy an annuity at any age — it depends on the provider’s requirements. In fact, some annuity companies allow you to purchase an annuity for a child. However, the best age to buy an annuity depends on your specific situation. 

For example, let’s say that you’re in your 30’s. You’re contributing to a 401(k) and have $10,000 in debt. You then receive a $20,000 inheritance, After paying off the debt, you could put the remaining $10,000 into a deferred annuity so that you’ll have a guaranteed income stream in the future. 

But, if you are nearing retirement age, or have already retired, an immediate annuity makes more sense. This is because you can purchase the annuity with the money in your IRA. This will give you an immediate income stream for the rest of your life. 

Does the stock market freak you out? 

“Typically when a financial advisor offers you a guarantee, you have to tread carefully,” says Jeff Rose, CFP. “But if just watching CNBC elevates your blood pressure too much, then an annuity is the answer.”

“Equity-based investments tend to fluctuate in value, which is to say that they can go down as well as up,” he adds. “But annuities can protect your principal value, ensuring that your investment remains fully intact to earn income in the future.”

“This can be especially important if you are very close to or are already retired,” states Ross. “Annuities can provide an immediate income and eliminate the worry of making up potential losses.”

What’s your ability to reduce spending and expenses in case of unexpected events? 

You may not need an annuity if you’re able to cut back your spending when the market isn’t performing well. Or, if you have an emergency fund that will take care of unexpected expenses, like a bill for a medical procedure. 

What’s your current health and family history?

Take a couple of minutes and assess your current health, as well as your family’s history. Doing this can give you an idea if you expect to live longer than the average life expectancy, which is close to 80. If so, you should consider an annuity so that you won’t outlive your money while also receiving lifetime payments. 

If you’re in poor health, however, an annuity may not be a smart investment. 

Is leaving a legacy more important than a retirement income?

With an annuity, there’s a tradeoff. You are exchanging access to the principal for lifetime payments. If you don’t have any heirs, this isn’t a problem. 

But, if you do, it could affect the amount you’re allowed to leave as a legacy. Usually, the payments your heirs receive are lower.

What’s more important? Greater control over assets or higher lifetime income?

Guaranteed lifetime payments are often the primary purpose of an annuity. But, there are some drawbacks. For starters, there are annual costs and fees that will lower the return on your investment. Additionally, control of these assets is restricted. At the minimum, this includes withdrawal limitations and investment options. 

But, if you don’t need to access your funds and can afford the costs associated, you’ll receive a higher lifetime income. 

Moreover, before making a final decision, speak with your financial advisor. And, it also wouldn’t hurt to ask the additional questions:

  • What are the risks of an annuity?
  • Will an annuity help you with your financial objectives and time horizon?
  • Are the features and benefits in the annuity, other than tax deferral appropriate for me?
  • Does my annuity offer a guaranteed minimum interest rate?
  • Does the annuity include riders? If so, how do they work?
  • Am I taking full advantage of all of my other tax-deferred opportunities including 401(k)s, 403(b)s, and IRAs?
  • Do I understand the fees, charges, and adjustments that come with an annuity?
  • Is there a limit on how much I can take out annually without paying a surrender charge? Is there a limit on the amount that I can withdraw during the surrender charge period?
  • How will an annuity impact my tax liability?
  • How can I guarantee that my beneficiaries will receive any payment from my annuity if I die?

If you’ve answered these questions and decide to buy an annuity make sure to review the contract. If there are parts that you don’t understand or you spotted hidden fees, you do have 30-days to change your mind.

Buying an Annuity

You should get quotes from at least three insurers before choosing an annuity since payout amounts and options vary. You also may want to buy annuities from more than one company, depending on your state guaranty association’s insurance limits. If your state protects only $100,000, for instance, you could buy $100,000 annuities from three different companies to stay within those limits.

Even though this insurance exists, it’s no substitute for making sure you buy annuities only from financially strong companies. Insolvencies take time to resolve and your payments could be held up for years.

“You want to be sure that the company is well off enough financially and strong enough financially that they can make the payment long term to you,” Russell says.

Check the insurer’s ratings with one or more rating agencies (A.M. Best, Fitch, Moody’s, and Standard & Poor’s) — an “A” rating indicates the company is financially strong enough to be around as long as you need it.

If you’ve done the suggestions listed above, assessed your current and financial needs, and found an annuity product that works best for you, it’s time to buy an annuity.

Your first step will be selecting your provider. We at Due make it easy to get started. Additionally, insurance companies like American Equity Investment Life Insurance Company, Nationwide, AIG, and Prudential are good places to start. But, it’s recommended that you turn to a rating agency like AM Best to check out the financial strength and soundness of the company.

Outside of insurance companies, you can buy annuities from:

  • Due Annuity
  • Annuity distributors, think large brokerage firms, like Merrill Lynch and Morgan Stanley.
  • Independent broker-dealers, such as Raymond James.
  • Well-known national banks like Bank of America.
  • Mutual fund companies including Vanguard and T. Rowe Price.
  • Independent agents, brokers, and financial advisors.

After locating a provider, you’ll need to fill out an application in order to lock in your rate. After that, you can transfer funds. You can do this by paying with ecash, retirement funds, or transferring money from a brokerage account.


Chapters - Annuity

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