Selecting an Appropriate Annuity Type
Selecting an appropriate annuity type based on the age of the investor varies. However, certified financial planners and accountants usually agree that between the ages of 45 and 55 is the optimal point at which to purchase an annuity. An annuity, combined with other retirement accounts, will grow tax-deferred. And, annuities can guarantee that the owner has a guaranteed stream of income for life after he or she retires.
The average annuity investor can usually incur more risk with his or her investments between the ages of 45 and 55. After the age of 55, there isn't time to make up for losses that can occur with riskier investments. He or she can choose among several annuity options that are best suited for his or her financial goals. After the age of 59½ or retirement, annuity investors are more likely to purchase immediate annuities to provide guaranteed income.
Market Risk and Selecting an Appropriate Annuity Type
Annuity investors have three choices when choosing annuities that are best suited to their risk tolerance: Fixed, variable and indexed. The choice should also take into account the other types of investments the investor has and how the annuity fits into the overall investment plan.
Fixed annuities are best suited for older investors who have less time to save for retirement and therefore want to take fewer risks. An investor who is "risk averse" doesn't want to risk as much of his or her money in the stock market. This type of annuity investor may alternately have other investments that are deemed higher risk investments. A fixed annuity earns a guaranteed set amount on the principle. Returns of between 3% and 10% are common. Investors are always advised to compare the fixed annuity products by several companies before making a final selection.
Fixed annuities are usually purchased with a single, lump-sum premium. A fixed annuity investor can therefore purchase as many fixed annuities in any amount at any time. This annuity is often ideal for people who receive the proceeds from the sale of equities, bonds, or a house, or for those who have received an inheritance.
Investors who choose variable annuities are selecting annuities that invest in the stock market. The premiums that are paid to the insurance company are put into an account that invests in stock, bond or money market funds. A choice can also be made for investments in a combination of the three. Variable annuity investors can select from aggressive, moderate or conservative investments. Gains are never guaranteed, but they can be higher than those of fixed annuities.
A variable annuity is a good choice for an investor at retirement age who needs to make up for a savings shortfall. While the risk of a variable annuity is sometimes greater than that of a fixed annuity, an investor can minimize his or her risk by selecting diverse funds.
The payout on variable annuities will usually fluctuate based on how well the underlying funds within the annuity do. An investor looking to purchase a variable annuity must always make sure that he or she has additional assets and the ability to access liquid cash reserves for unanticipated monthly expenses and emergencies. Even though the returns of variable annuities can be higher than those of fixed annuities, so can the risks.
An indexed annuity is a cross between a fixed annuity and a variable annuity. The amount of growth and the payout are tied to the performance of a particular market index, most often the S&P 500. The returns paid are typically capped on the upside and contained on the downside. For example, if the upside cap is 6%, the account will be credited 6% even if the S&P 500 rises by 7%.
One significant advantage of indexed annuities is that the principle is never at risk. No matter how sharp the decline of the index, the risk is limited to the interest earned. This is a great scenario for an investor who wishes to participate in the equities market without taking on exceptional, and potentially devastating risk.
Guaranteed Income and Annuity Types
It's no secret that life expectancy in the United States has been on the increase. Retirees now run the risk of outliving their savings. While investing in the stock market can present the risk of loss over shorter periods of time, historically it has out-performed all other investment options. Financial planners and actuarial accountants know that the older an investor lives, the more likely he or she is to stay alive. In other words, even though the life expectancy of an American man is currently 78 years, a man who reaches the age of 78 is likely to live to the age of 85.
Retirement income needs to perform two very important tasks: It needs to last as long as the person who receives it is alive and it must keep pace with the rate of inflation. Next to outliving the assets he or she has accumulated, the greatest risk to a retirement investor is inflation. In addition, other retirement investors need to make sure that a surviving spouse is guaranteed a stream of income following his or her own death. The original annuitant may want to consider a permanent or term life insurance policy in order to provide a guaranteed death benefit to the spouse as well. Investors can also consider adding a cost of living adjustment (COLA) rider as an extra hedge against inflation.
All of the options above are available with any of the three annuity types. Selecting an appropriate annuity type will take into account the financial needs of the investor while accounting for the proper level of risk tolerance the investor has. It's always important to remember that the annuity or retirement investment that is best for one person won't be the best for another. And, when it comes to selecting an appropriate annuity type, an investor should always make sure the investment fits his goals.
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