If you’d like to have a steady stream of income in retirement, you might want to add an annuity to your portfolio. First, make sure you understand the terms and weigh the pros and cons.
How an Annuity Works
When you take out an annuity, you’re making an agreement with an insurance company. You’ll contribute money, either in a lump sum right away or in regular premium payments over time. In exchange, the insurance company will provide you with income, either in a lump sum or in a series of payments.
With a tax-deferred annuity, money that you invest will grow tax free. You won’t have to pay taxes until you begin to collect payments.
It’s important to note that an annuity is not the same as a life insurance policy. An annuity is meant to provide income while you’re alive. A life insurance policy will pay a benefit to your beneficiaries after you die.
Review the Terms Carefully
If you select an immediate annuity, you’ll start to receive payments right away. If you choose a deferred annuity, you’ll begin to receive money later, most likely when you’re retired.
You might receive payments for a limited amount of time or for the remainder of your life. Depending on when you begin to receive payments and how long you live, you might or might not collect enough to make an annuity worthwhile financially.
The amount of money you’ll receive will depend on the kind of annuity you select. With a fixed annuity, you’ll get a specific rate of return on your investment and will have predictable payments. With a variable annuity, the insurance company will invest money you contribute, and the amount you receive will depend on how well those investments perform.
Consider the Benefits and Costs
Financial advisors generally charge higher commissions for annuities than they do for other types of investments, such as mutual funds. In addition, annuities tend to have higher fees and maintenance charges than other financial products. If you withdraw money from an annuity ahead of schedule, you might have to pay a surrender charge and/or tax penalty.
You can customize an annuity so you’ll receive a guaranteed minimum income, so your spouse will continue to receive payments after you die, or so your children will receive a death benefit. Those sorts of riders can provide additional peace of mind, but they can also come with hefty fees.
Choose the Strategy That’s Right for You
Annuities can be structured in numerous ways. Review the specific terms before you decide whether to invest in one.
If you like the idea of having a steady income after you retire, but you don’t want to pay a lot in fees, you can invest in a 401(k) or an IRA, then shift money to an annuity as you get close to retirement age. That will provide the income that you’re looking for and let you avoid paying high fees for years before you retire.
