Running out of money in retirement is a legitimate fear. And most Americans aren't saving enough — a recent study found 75% of Americans won't be able to maintain their lifestyles when they retire.
Enter the annuity, an investment that promotes safe, long-term growth (and a lifetime payout).
Annuities are an extremely popular way to save for retirement. In 2018 fixed annuity sales grew 27%, based on data from trade research organization LIMRA.
But they are often confusing and complex. Here’s how to know if an annuity is right for you.
How do annuities work?
Annuities are investment products sold by life insurance companies. The money grown inside an annuity is tax-deferred, like a retirement plan,meaning you won’t pay taxes on the growth until you withdraw it. The real draw to annuities is fixed income for the rest of your life.
Two popular types of annuities are fixed and variable. Fixed annuities earn interest at a predetermined rate, while variable annuities which earn interest tied to market trends.
“An annuity can be an option for someone that is concerned about running out of money in retirement,” said Alexander Koury, certified financial planner and advisor at Values Quest. “They want guaranteed income that will last them during their lifetime.”
If you have an annuity, you’re entitled to a fixed amount of money every year until the annuity expires or you pass away. You can also leave an annuity for someone else in your will that will pay out yearly.
Learn more about annuities here.
Why you may not want to buy an annuity
Annuities often have lower returns than other types of investments, said Koury.
For starters, the periodic payments are fixed, losing value to inflation over time. Annuities are also extremely illiquid, meaning it can be difficult to get ahold of the money before the payout period, similar to retirement funds.
If an emergency arises, you can access your funds for a steep fee. If you make a withdrawal in the first few years, known as the accumulation phase, you could be faced with a 7% surrender charge. Early withdrawals can also trigger a 10% IRS penalty, so be wary of that. Some annuities have additional commission and management fees taking a percentage of your investment.
These fees and the complicated nature of annuities often lead a customer to spend more than they need on extra riders or higher premiums.
“Annuities are often sold with a bunch of bells and whistles, known as riders,” said Kashif Ahmed, certified financial planner and president of American Private Wealth. “Most of the time they are not worth buying. The more you tack on the more it increases the cost.”
Weigh your personal financial situation when considering an annuity, added Koury.
“No two annuities are the same,” he said. “They all have different features that may or may not be important to a person's circumstances and goals.”
When you may want to consider an annuity
You may want to consider an annuity once you’ve maxed out all your other options, like 401(k)s and IRAs. If you have extra money to set aside for retirement, an annuity's tax-free growth may make sense.
Annuity payments can also cover your partner’s lifetime. If you’re worried about your loved one running out of money after you’re gone, an annuity may be a good way to cover them
Life insurance is another option. Learn about life insurance for seniors here.
All in all, it’s best to consult a financial professional before purchasing an annuity. Here’s how to find one.