Annuities have long been frowned upon by consumers and even some financial advisors as well. But do they deserve to be immediately dismissed as a solution? You may have heard the saying, “Annuities are sold, not bought”, which we believe may have held some truth back in the day, but not necessarily anymore. In certain situations, an annuity may be a suitable strategy to help you achieve your financial goals.
The basic definition of an annuity is that it’s a long-term investment that is issued by an insurance company and is designed to help protect you from the risk of outliving your income1. One of the most popular examples of an annuity is Social Security.2
Although annuities are created to provide an income stream, many consumers buy them for wealth accumulation purposes. When looking at annuity options, there are generally four different types available1. Which is best depends on several variables, including your risk orientation, income goals, and if/when you want to begin receiving annuity income.
–Single Premium Immediate Annuity (SPIA). These annuities require an initial lump sum of money up front, also known as a premium, in exchange for guaranteed, periodic payments for life or over a set period of time. This annuity is the oldest type and pays out an income immediately rather than allowing for accumulation. Those who have a pension or would like to have the cash accessible would generally not benefit from a SPIA.1
–Fixed Annuity. Fixed annuities, along with Indexed and Variable annuities, are generally considered deferred annuities. Instead of received an immediate income stream, these products are design to earn money before deciding to annuitize. Fixed annuities are similar to certificates of deposit (CD) in that they provide a fixed rate of interest for a specified period of time. In most cases the longer the contract, the higher interest rate you will receive. Fixed annuities are typically considered the simplest and most straightforward type of annuities as they provide predictable and reliable earnings. As with most annuities though, there are hefty penalties for withdrawing before the contract matures.1
–Indexed Annuities. Sometimes referred to as Fixed-Index Annuities or Equity-Index Annuities, these products are tied to a stock index, such as the S&P 500. Indexed annuities offer more potential for growth over a fixed annuity but does come with additional risks as well. Since these annuities mirror the performance of a stock index, earnings can be volatile but also opportunistic. In most cases, indexed annuities also provide downside protection from underperforming markets meaning if the market is at a loss, you won’t lose any money. Because of this feature, there are caps on how much you can earn on the upside.1
–Variable Annuities. These annuities offer the most opportunity for capital accumulation but also brings increased risk exposure. The returns are tied to an investment portfolio that can be selected from a subaccount of various funds. The major difference with variable annuities is that you have potential for much greater returns but they do not offer any downside protection.1
In summary, you have different types of annuities depending on your risk tolerance and overall financial goals. Keep in mind that many of these annuities may offer some types of protection but may carry steep penalties if withdrawn too early and/or before the age of 59-1/2. Again, annuities are not right for everyone but can be used appropriately in certain situations.