Are Annuities For Retirement The Best Choice?

After years of hard work, everyone wishes to have enough savings to spend during retirement. After all, no one wants to work for the rest of their life.

When people think of investing for their retirement, they might see images of Wall Street.  High-stakes, big energy trading floors might come to mind.  Annuities for retirement are a less flashy way of preparing.  They’re also not considered as investments in the financial world. They are insurance products meant to give you a guaranteed retirement income when done right. Nonetheless, annuities might not work for everyone.

Before investing in annuities or opting out of them altogether, you should have a clear picture of what annuities entail.  In this article, we’ll look at the pros and cons of annuities for retirement.  Once you’ve finished the article, you’ll know if annuities for retirement are a good fit for you.

SO, HOW DO ANNUITIES WORK?

Annuities are contracts between investors and insurers. You will contribute money either as a lump sum or in small payments over time. In return, the insurer pays it back as a regular income stream over a specified time frame. You can start receiving payments immediately or have them deferred to some point in the future.

Furthermore, annuities can be variable or fixed. In fixed annuities, an insurer will pay a specific return rate on your investment. In variable annuities, insurers invest your money in ‘’sub-accounts’’ or mutual funds. The performance of the investments you will choose determine your returns.

Fixed annuities are the most popular type of annuities for retirement. Their fixed interest rate provides comfort to those nearing retirement when compared to mutual funds.  Let’s look at some other pros and cons with using annuities for retirement.

PROS OF ANNUITIES FOR RETIREMENT

Economists have studied the ‘’annuity puzzle’’ for ages to understand why investors shy away from annuities. In a white paper by the National Bureau of Economic Research, researchers recommended that a more conservative portfolio should include more annuities.  The idea is to use annuities to protect yourself against uncertainties in the future.

The following are key benefits of annuities for retirement:

• Lifetime income: The most attractive benefit of annuities is that they provide incomes that few people outlive. This is unlike traditional retirement investments whose returns most people with modest means often outlive.

• Deferred distributions. The tax-deferred status of annuities is another perk of investing in them. With most popular investments like certificates of deposit, you pay taxes when your investment matures. In annuities, you are not taxed until you withdraw your cash. This gives you some control over when you pay taxes and allows your investment to grow tax free.

• Guaranteed returns. With fixed annuities, you are sure of your rate of returns for a specified timeframe.  This can help you to budget appropriately.

CONS OF ANNUITIES FOR RETIREMENT

Some of the disadvantages of annuities include:

• Hefty fees: The main concern with annuities is their higher fees compared to CDs and mutual funds. You can buy annuities through agents who get paid commissions via a high upfront sales charge paid by an investor. Even when you buy an annuity from an insurer, you might part with over 2% of your investment in annual expenses.

• Lack of liquidity: Most annuities charge a ‘’surrender fee’’ that investors incur when they try withdrawing their cash within a certain period after investing. Usually, this locked-in period is 6-8 years.

• High tax rates: Though annuities are tax-deferred, the net returns on your investment are taxed as ordinary income when you withdraw them. This could mean a high capital gains tax rate based on your tax bracket.

• Complexity: One rule of investing for retirement is never to buy what you do not understand. In the past few years, the insurance market has seen the introduction of several exotic variants of annuities, which are quite complicated.

ALTERNATIVES TO ANNUITIES

If annuities don’t match your plans, this doesn’t mean you have no option for getting an income during retirement. Here are a few tidbits on the popular alternatives to annuities for retirement:

• Defined contribution plans.  In these plans, employers contribute a part of your salary to your retirement account. The 401(k) plan to which you will contribute to retirement with your pre-tax wages is the most popular. With it, you can grow your retirement account tax-free until you withdraw funds at retirement.

• Defined benefits plans. In these plans, an employer sets up and maintains a pension plan that pays employees when they retire. In a few plans, employees also contribute to their retirement with diverse benefits. The cash balance plan, for instance, defines your promised benefits as stated account balances.

• IRAs.  The U.S. government designs the IRA plan to help people save for retirement. You contribute a set amount to your IRA account and access your savings after retirement. Some of your IRA plan options include the traditional, Roth, spousal, and rollover IRA plans.  See our article on tax-free retirement accounts and how to jump start your retirement investing.

From the elements covered above, you should be more sure of how annuities for retirement work. If you want a reliable income stream in retirement, consider including annuities in your retirement plan. But, if you are looking for a short-term investment option, annuities might not be your best choice. These are intended to be long-term investments for the highest returns.  While annuities are a solid part of your retirement portfolio, make sure they fit your unique circumstance.