For many Americans, their current retirement savings, combined with Social Security payments, will not be enough to maintain their current standard of living. Many are looking for ways to add increase income to their monthly income. Annuities may be the answer. But annuities can be complicated. Be sure to know what you are purchasing before you make your purchase. Here are 5 things to consider before buying your first annuity.
- Types of Annuities to Consider. There are a variety of annuities and which type you buy depends on what you are hoping to achieve. I’m not a big fan of variable annuities as they seem to be too costly, so they are not being mentioned here.
- Fixed Annuities earn a set interest rate every year. They are guaranteed not to earn less than a certain interest rate every year.
- Fixed Indexed Annuities allow you to participate in a return that is linked to an index such as the S&P500 typically at a participation rate or a capped rate but with no downside risk.
- Immediate Annuities allows you to get a specific amount of income paid to you monthly or annually for life. You can add period certain to make sure the income stream will go to your heirs if you die prematurely.
- 2. Fees. The type, number, and amount of fees involved will vary according to the institution where you purchased your annuity. Be sure to ask about and understand what fees you will be charged. Some examples are:
- Commission fee – annuities are sold by insurance agents and as such, can pay commissions typically in the range of 5.5%-8.5%. Your contract is not being reduced by the amount as the insurance company has calculated the compensation into the solution.
- Annual fees. Typically, the annual cost of an annuity is built into the solution and you will not be charged a fee. The Indexed Annuity typically has an annual cost if you have added an income rider. The cost varies typically from 0.6% to 1.2%
- Early withdrawals or Surrenders. If you decide to close your account early there can be a penalty of typically up to 10% (It can be higher). The further into that surrender period, the lower the penalty. If you withdraw prior to age 59 ½ there can be penalties, unless you take the same amount out periodically until you reach 59 ½. There is a specific calculation that would need to be in place to avoid the penalty.
- First Year Bonuses. Some annuities offer first-year bonuses on deposits made during the first year of purchase. This bonus typically ranges from 5%-18%. This can greatly increase the balance earning interest and are typically best for people that want to take income within the first 1-5 years.
- Taxable Deposits. When you fund an annuity, you are making fairly large deposits into an account. The money, along with interest, will then be used to provide a steady income stream to you, either now or in the future. Unlike 401(k)s or IRAs, these deposits are not tax deductible. You fund an annuity with after-tax dollars. The savings comes from the interest earned on the account. Withdrawals are taxed up until the initial funds have been drawn from the account. After that, interest earned is tax-free, which can be nice savings for you.
Annuities can provide a nice income stream for you during your retirement years. Be sure to understand the terms and conditions involved you will have additional income that you will not outlive.