Is knowing what's an annuity crucial for your retirement planning?

Financial jargon can be confusing for everyone, retired or not.

It's possible to miss out on financial opportunities purely because you don't fully understand the potential of the market and the meaning of some concepts.

At SovereignBoss, we've researched the top information on the subject and we're here to share. Now, let's look at everything you need to know about annuities.

Let's dive straight in!

What's an Annuity

An annuity is a way of investing funds to be paid out to you in the future, typically in your pension years¹.

Why's this great?

You're guaranteed an income for the rest of your life.

Technically, an annuity is a series of payments made at regular intervals over a fixed period of time.

You will then receive your income or capital accumulation during a contractually defined or agreed-upon period of time.

Annuities are often associated with retirement planning because they offer guaranteed lifetime income and lump-sum payouts!²

Types of Annuities

The best way to make an informed decision about your retirement investment is by understanding the different types of annuities.

A few common categories include:

Timing of Payments

Annuity-immediate payments³ are due at the end of a payment period, so interest accumulates between the time the annuity is issued and the first payment.

Payments of an annuity-due are made at the start of payment periods, resulting in an immediate payment to the issuer.

Contingency of Payments

Certain or guaranteed annuities work by you making payments over a predetermined duration.

Contingent annuities⁴ are only repaid under certain circumstances.

A common example is a life annuity, which is paid out over the annuitant's remaining lifetime.

Certain and life annuities are guaranteed to pay for a certain number of years before becoming dependent on the annuitant's survival.

Variability of Payments

The variability of annuity payments depends on the type of annuity.

Let's take a look.

Fixed Annuities

Fixed-payment annuities work with a predetermined return on the initial investment if the service is supplied by an insurance company.

Variable Annuities

Variable annuities enable direct investing into a variety of funds designed specifically for variable annuities.

In most cases, the insurance company promises a certain death benefit⁵ or lifetime withdrawal benefit.

Equity-Indexed Annuities

Payments are linked to an index in an annuity. The minimum payment is usually 0%⁶, and the maximum payment is fixed.

The performance of an index decides whether the consumer receives the minimum, maximum, or something in between.

Deferral of Payments

A deferred annuity is one that pays out after a set period of time, usually after retirement.

On the other hand, an immediate annuity works when you pay a lump sum, in return for a regular and guaranteed income.

Pros of Annuities

The pros of annuities include having a guaranteed income for the rest of your life.

Let's look at some more pros:

• Guaranteed income for the rest of your life.
• It's not subject to stock market fluctuations.
• It's an income to rise with inflation.
• Because of your poor health, you'll be able to earn more income.

Cons of Annuities

The cons of annuities include their unpredictability.

Let's look at some more cons:

• You won't benefit if your life expectancy is quite low as they are generally long-term plans.
• You might be hesitant to take a chance with the annuity rate as it can be unpredictable.
• You want to keep your money invested through alternative means.
• You may change your mind.

Government Incentives

Annuities generally have a favourable tax status⁷, which may alter how appealing they are relative to other investment options.

This is due to cross-subsidy and the guarantees an annuity can provide against running out of income and being dependent on state welfare in an old life.

In some countries, immediate annuities are a required component of some pension saving systems where the government offers tax breaks if money is put into a fund that can only or mostly be withdrawn as an annuity.

Common Questions

In Conclusion

Annuities are long-term investments that provide guaranteed income for life.

They can be structured in many ways to suit your needs, including as a fixed annuity, variable annuity, or equity-indexed annuity.

An important factor when deciding which type of annuity is best for you is the amount of risk you're willing to take on.

If you prefer a low-risk option, then a fixed or variable annuity may be right for you; if not, an equity-indexed might make more sense.

Now that you know what's an annuity, talk to a financial advisor for personalised guidance.