A little while ago, I wrote a detailed post on annuities. Basically, an annuity is a hybrid between an insurance product and investment product. All annuities are different, but in one way or another, they are an investment that come with some kind of guarantee or ‘insurance’ built in.
While knowing what an annuity is and how an annuity works is important, it’s also important to consider why you might buy an annuity. You shouldn’t plunge into annuities blindly, but you also shouldn’t write them off completely. There’s a time and place for everything, annuities included.
An Annuity Can Secure Retirement Income
One of the most popular reasons for buying an annuity is to insure against outliving your retirement savings. It’s impossible to predict how long you will live. If you draw down traditional investments as retirement income, you run the risk of depleting your savings while you are still alive. By buying an annuity with a lifetime income rider, you secure a guaranteed monthly income for as long as you live.
An Annuity Can Protect Retirement Savings From Market Losses
Some annuities come with principal guarantees. This kind of guarantee usually comes on an annuity that tracks the stock market and guarantees that you will not lose the money, but still exposes you to potential gains in the stock market. Of course, this guarantee isn’t free, and either limits your stock market gains, costs a fee, or both. However, a principal guarantee might be a wise option as you are approaching your retirement and can’t afford to take huge market losses in your nest egg, but still want to be exposed to some potential gain.
An Annuity Can Motivate You To Invest
The stock market is volatile, and your investments are liable to take losses. Even though these losses are temporary (as long as you don’t panic and sell), some people can’t stomach the thought of this volatility and instead keep all their money on the sidelines (in the bank), where it earns piddly interest. Although annuities will return less than the stock market in the long-term, they are still a far better investment than cash. For someone who refuses to risk their money in the stock market, the safety of an annuity may be the best place for their money to grow.
An Annuity Can Shield Your Investments From Your Own Emotions
Again, the stock market is volatile. When the market takes losses, many people panic and sell, locking in their losses. If you know you can’t handle the ups and downs, and if you know you’re likely to panic and sell when the market takes losses, you may be better off in an annuity that guarantees you won’t take losses.
An Annuity Might Offer Tax Benefits that Other Investments Don’t
For many people, IRAs and 401ks offer similar tax benefits as annuities. However, if you’ve maxed out these retirement options, annuities offer deferred growth. In other words you’re not taxed on income until you start making withdrawals. However, since everyone’s tax situation is different, consult a tax pro on how an annuity would affect your situation, and on whether you have other options that would suit you better.