So you’ve got a several other retirement funds already waiting in the wings like and IRA, a 401K, or maybe even both. However, you want to do something else with your money and you’ve heard of annuities. When deciding whether to enter a particular venture or not, annuities are not different from how you would normally decide on a course of action.
The annuity pros and cons are important factors so that you’ll know whether or not it’s worth devoting a chunk of your retirement money to it.
What is an Annuity?
First, before we get into the advantages and disadvantages of annuities, what is an annuity? An annuity is a financial product that is sold by insurance companies, usually to people looking to have a steady income when retirement comes. Annuities are paid out over time and are tax-deferred until withdrawal. A qualified withdrawal or distribution can only be made when the annuitant reaches the age of 59 ½ years. If a withdrawal is made before that age, penalties will be incurred and is usually about 10% of the withdrawal plus automatic application of tax.
There are even different kinds of annuities, the foremost of which are variable annuities and fixed annuities.
Different Kinds of Annuities
Variable annuities are like mutual funds wherein the principal is put into sub accounts or investments that earn interest based on the stock market. What are the variable annuities pros and cons? Variable annuities can have enormous gains depending on the market upswing and will provide you with a comfortable lump sum after the accumulation period ends. Of course, the downside is that there is no stable income and no regular payment unless you decide that your earnings will be converted to a paid out income when the annuity matures. You could also suffer severe losses should your investments fall with the market. This is bad especially since any eventual income will be based on the entirety of your gain and loss accumulations. Annuities pros and cons of this nature are easily distinguished and it should be pretty easy to decide whether you’re a risk-taker or not.
The other kind of annuity, fixed annuities, are the more traditional type. These kinds of annuities suit conservative people as they have a guaranteed payout upon maturity. With a fixed investment income like this, the only condition is that you pay a lump sum payment upfront. After that, it’s just a matter of waiting until retirement and this funds supplement is yours with guaranteed earnings and principal. Equity indexed annuities are fixed annuities with the added bonus of flexibility. Basically, what you have is a hybrid of fixed and variable annuities. What are index annuities pros and cons? On the good side, you’ve got guaranteed earnings and income upon maturity like what you’d get from a fixed annuity. Another plus is that you can also earn interest which is linked to a stock index. The downside is that you won’t get 100% of your earnings no matter what you do. This will be the trade-off for guaranteed gains.
With these annuities explained, it is also a good idea to know that annuity loans are possible in case you encounter a situation in which you need money immediately. This counts as a positive on the list of annuities pros and cons because all annuity loans are tax-deferred and may be borrowed against for up to half of the account balance. It’s also pretty nice that the loan will remain tax-free even when taken out of the account unless you somehow fail to pay back the loan in the allotted time.
There is a kind of annuity called charitable gift annuity that lets a ‘donor’ give an annuity to an ‘annuitant’ but that’s a different business altogether from the basic types of annuity.