It is always a good time to build or add to your retirement plan. If you haven’t already, then, you might consider augmenting your savings strategy with annuities, which have the potential to provide you with a steady stream of income after you leave the workforce. Not all annuities are the same, so let’s examine some of the most common types and how best to use them to your advantage.
How Do Annuities Work?
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Though there are several types of annuities to choose from, they generally work in the same way. First, you purchase an annuity contract from an insurance company, bank, or broker. Then you fund the annuity with either a lump sum or a regular series of payments, as from a checking, savings, investment, or retirement account. During what’s known as the accumulation phase, the account grows tax-deferred according to a particular interest rate.
At the end of the term, you have the choice to renew your policy, roll it over into another type of annuity, or cash out. Should you cash out, you’ll begin to receive regular distributions of income for either a specified period or the rest of your life. Your distributions are subject to income tax, and you’re subject to a penalty tax if you begin to receive payments before you turn 59.5 years old.
There is more than one form of annuity. The United States Securities and Exchange Commission specifies three primary types:
Fixed Annuity
With a fixed annuity, the annuity provider guarantees you a fixed interest rate for the life of the contract. Because you know the rate at which your account will grow, fixed annuities allow you to calculate how much you’ll receive in regular distributions once you cash out. This can make your retirement planning much easier.
Variable Annuity
A variable annuity offers fluctuating interest rates based on market performance. The annuity provider invests your contributions in a portfolio of assets that you select. When the market does well, you earn a higher rate of return, but it’s lower when the market does poorly. While the fluctuations present some risk, you also stand to grow your money at a faster rate.
Indexed Annuity
An indexed annuity, also known as a fixed-index annuity, is somewhere between a fixed and a variable annuity. It offers you principal protection along with the potential for higher gains by being tied to the performance of a market index, such as the S&P 500 or Dow Jones. It’s more hands-off than a variable annuity in that the annuity provider selects your assets for you. Otherwise, your account grows similarly to a variable annuity, with a higher rate when the index performs well and a lower one when it performs poorly.
What’s the Best Age To Purchase an Annuity?
If you’re wondering about the best age to purchase an annuity, you should know there isn’t a one-size-fits-all answer. It depends on your retirement goals and individual circumstances. That being said, certain annuity types are better suited to particular age groups based on likely financial circumstances. With that in mind, consider the following recommendations:
40 to 50 Years Old: Variable Annuities
Remember, variable annuities present some degree of risk, and you could end up short of your growth goal if the market consistently performs below average. When it comes to the market, holding investments over a longer term allows you a larger window of opportunity to ride out the market lows and take advantage of the highs. By starting with a variable annuity at a younger age and regularly renewing your policy, you reduce your retirement risk while increasing the potential for long-term gains.
50 to 60 Years Old: Indexed Annuities
Being closer to retirement, many 50-to-60-year-olds endeavor to pursue two goals that are often mutually exclusive: maximizing growth and minimizing risk. Fortunately, an indexed annuity can offer both in a single package. With principal protection, you can rest assured that you won’t lose the money you’ve put into your annuity account, while rate variability offers the potential for higher-than-average growth.
Mid-50s to 70: Fixed Annuities
If you’re in your mid-50s to around 70 years old, chances are that you want to bring your risk as close to zero as possible. A fixed annuity can help you do that since it isn’t tied to market performance and its growth rate is guaranteed from the start. Given that you’re in a position to calculate your retirement expenses, the predictability of a fixed annuity can be helpful in terms of budgeting.
Before you commit to purchasing any type of annuity, make sure to develop a clear picture of your financial means and goals. Speak with a financial adviser, if possible, to help you build a diverse portfolio that meets your needs, and use annuities wisely to supplement your income.
Disclaimer: This content does not necessarily represent the views of IWB.