In the past I’ve written about stocks, bonds mutual funds and ETFs. However, there are other types of investment instruments that I haven’t written about. In this post I’ll cover some of the basics regarding annuities.
What is an annuity?
An annuity is a contract with an insurance company to pay you an income stream. Sometimes there is an investment component where funds within the contract vary with the stock market, and the stream of income will be delayed until some point in the future. When the contract is “annuitized,” then payments are made.
Types of annuities
There are many different types of annuities with terms in each contract that can vary. This causes things to get confusing fast. If you search for “annuity definition Investopedia” online, no less than eight show up! I’ll cover a few key types and terms. First, let’s look at variable vs. fixed annuities. With a variable annuity, the eventual payment will “vary” depending on investment performance, whereas a fixed annuity contract guarantees a “fixed” stream of payment that doesn’t fluctuate. Also, there are immediate vs. deferred annuities. With an immediate annuity, the payments begin “immediately” with a deferred annuity the payments are delayed until the contract is annuitized. Then, payments will be made. You can choose to have the payments last for a specific amount of time or for the life of an individual(s). This can be a helpful option for couples. When the contract covers the life of two individuals, it’s called a joint life annuity.
Who might benefit from an annuity?
Annuities are generally best suited for retirees who need income. They can be a helpful tool to create fixed income in retirement. In some cases they have been used as replacements for traditional pension plans.
Sometimes a fixed annuity can be used to augment the bond portion of a diversified portfolio.
Like any investment, there are other trade-offs when it comes to annuities. Annuities tend to have high fees in relation to other investments. They also can be illiquid due to high surrender charges. Be sure to consider the financial strength of the company who is issuing the annuity, because this could affect the risk of your investment. If you already own a variable annuity, this article by fee only planner Mike Chamberlain offers helpful guidance.
Consider annuities as well as other investment choices in the context of your overall financial plan so that you can SaveUp!
This post was written by SaveUp’s personal finance contributing writer, Catherine Hawley, CFP®.
Image source: Nick Youngson