Annuities are not an investment the way stocks and bonds are, though they may be invested in the market with your permission. Instead, annuities are an insurance product. They’re also very complex financial products. This is why many people make mistakes when signing up for one. Let’s learn more about the vital information you need before you commit to buy it.
Understand How Annuities Work
There are several distinct types of annuities. They include:
- Immediate fixed annuities
- Immediate variable annuities
- Deferred fixed annuities.
- Deferred variable annuities.
But regardless of the type of annuity, they have several shared traits. You must fund the annuity. This could be done via a single lump sum or regular contributions to the account. The money may grow at a rate just above the inflation rate, or it may grow at a variable rate tied to the market. But in every case, the value of the lump sum grows the longer you let it go untouched. At some point, the annuity is annuitized. This means that it is activated, and it shifts from growing to paying out money. You cannot reverse this process once it is begun. If you want to know your, you can learn how annuities work here.
Learn about the Trade-Offs Between Risk and Returns
A fixed rate annuity will pay less than a variable annuity on average, but you’re guaranteed a set rate of return or a certain payment every month. If you choose a variable annuity, you could get more money each month when the market is going up, but it could result in lower payments when the market is down.
There are other trade-offs you can make, too. If you wait longer to begin collecting, the payments rise because statistically you’re not going to collect it as long. However, the monthly or annual payments are also higher because the money had additional time to grow. On the other hand, you’ll receive less each year if you’ve opted for death benefits unless you pay extra for said death benefit rider.
Understand Your Options for Funding Annuities
Funding for annuities can come from a variety of sources. You could roll over the money from an old 401K or IRA into an annuity. You could use the lump sum payment from a pension plan to fund the annuity. You can make regular contributions to the annuity just as you could contribute to a retirement account. Unlike 401Ks and IRAs, there are no contribution limits for annuities.
Know Where You Can Get Annuities
Annuities are insurance products. You could enter an annuity contract with your current insurance provider, if they offer this financial product. However, you could get it through any other insurance provider, as well. That’s why you can shop for an annuity online just as you could shop for auto insurance or homeowner’s insurance. There are financial advisors who offer annuities as well as can recommend various investments, as well.
Learn about the Limits and Pitfalls of Annuities
Do not sign up for an annuity contract without reading and understanding it. There are many common misconceptions. For example, you shouldn’t put 100% of your money into the annuity, because you cannot borrow against it if you’re short on cash. The money put into the annuity may be pre-tax like a traditional IRA rollover or after-tax like money from your paycheck after you’ve paid income taxes. The source of the money going into the annuity will determine how you’re taxed on the annuity payments. However, the growth is always tax deferred. On the other hand, the money only grows during the growth phase. It won’t continue growing once you begin taking payments. This is in contrast to an IRA or 401K that can continue to grow as long as it is still invested.
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