We often hear the expression that an educated consumer is the best consumer. I believe this holds true, whether someone is purchasing an appliance or an annuity. When visiting a client for the first time, after a discussion of goals and objectives, I like to explain the four types of annuities.
- Immediate Annuity – This is similar to a personal pension and the most traditional form of an annuity. When you implement an immediate annuity, you will receive a set amount of money for a specific amount of time. You can choose to receive payments for as little as five years, as long as your lifetime, or your lifetime plus a certain number of years after your death, and the option you choose will dictate the amount of income you will receive. If you’re choosing a lifetime payment, the life insurance company will base its calculations on the average age of death for a male/female.
- Fixed Annuity – Similar to a bank CD, the insurance company establishes a guaranteed fixed interest rate for a certain number of years. Traditionally, a fixed annuity will have a slightly higher interest rate than a bank CD, and interest that is earned from a fixed annuity is tax-deferred, while it is not with a CD. Depending on the life insurance company, you can receive interest from your investment on an annual basis, or withdraw up to 10% as a free withdrawal. Outside of government treasuries and CDs, fixed annuities are considered the safest vehicle to place your money.
- Variable Annuities – In order to sell this type of annuity, an agent is required to be security licensed. I do not have these licenses and cannot discuss this option. If you are interested in learning more about this financial vehicle, you can connect with a properly licensed professional.
- Fixed Indexed Annuity – In many ways, this is a combination of the other three types of annuities. With a fixed indexed annuity, your principal is always protected, but you also have the ability to benefit from a percentage of the stock market’s gains without downside risk. All of your gains are tax-deferred and add to the principal on an annual basis. Once the interest is added, the new amount becomes your new principal. The insurance company will place the money that is deposited into bonds, and these bonds are used to track market indexes through options and will generate interest. If the options are profitable, the insurance company will share the profits with you. It is comforting to know that through this type of annuity, you can receive a guaranteed income for life, and no matter what is happening in the stock market, your principal is protected from downturns.
Financial studies have shown that Social Security payments encompass between 40-50% of an individual’s monthly income once they retire. The balance of what is needed comes from retirement plans or other monies that have been put aside, and an annuity is designed to bridge the gap between Social Security and other retirement savings. Ultimately, the goal is to retain your pre-retirement lifestyle throughout retirement. In order to maintain this goal, I recommend that four buckets of money be established:
- An income stream that will cover all the necessary monthly expenses.
- An emergency fund that will assist if there are any unexpected emergencies due to medical expenses, natural disasters, etc.
- Most retirees enjoy traveling, so be sure to have a travel fund.
- A financial plan that accounts for inflation. With advances in medicine, people are living longer. Thus, the retirement dollar of today will not go as far in five, 10 or 20 years. Often, the slight increase in Social Security will not compensate for inflation.
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