Why Should I Buy an Annuity
Throughout history, at least as far back as Roman times, annuities have provided a solution for anyone who sought the security of an income that they could not outlive. When you consider that today’s life expectancy is nearly three times that of a Roman citizen, the idea of a secure lifetime income takes on much more significance. Still, for many people, even with the knowledge that they may live much as a third of their life in retirement, the question of, “Why should I buy an annuity?” lingers on.
If one was to conduct and honest evaluation of his or her needs, priorities, risk tolerance and concerns for the future, especially in the face of today’s uncertain economy and markets, the answer may become clearer. But, only with a better understanding of the unique characteristics of an annuity, and their application in their specific financial situation, can someone definitively answer the question.
Let’s conduct that evaluation in the context of the features and characteristics of an annuity as a way to answer the question.
Guaranteed Lifetime Income
Beginning with the most predominate feature of an annuity, the promise that a person who deposits a sum of money with an insurer cannot outlive their income, one would assume that most people would desire nothing less. This may not have been an overriding concern at a time when many people didn’t live much beyond their earning years. Nor, was it a major concern during times of ballooning 401(k) plans and investment accounts during the extended bull markets of the 1980’s and 1990’s. But, if you ask the person who realizes that we may live 25 years into retirement, and, who saw their 401(k) decimated by the unpredictable market declines of 2008 and 2010, what his biggest concern is, you’re likely to hear a more sullen tone.
If your retirement is within your sights, and you have trouble predicting the amount or length of income that your assets will produce, an annuity should be among your primary considerations as retirement vehicle.
Safety of Principal
The old adage, “I’m not as concerned about the return on my money as I am with the return of my money” takes on a whole new significance for millions of investors who struggled through recent, major market declines. Generally, annuities provide for safe return of principal in the event that the annuity owner dies prior to annuitization (the time at which the insurer begins a guaranteed payout). Even after annuitization, the insurer guarantees that, should you live until your life expectancy, you will receive all of your principal back in the form of income (along with interest payments).
With annuities, safer of principal doesn’t necessarily come at the expense of a better return on your money. Aside from fixed annuities that offer a fixed yield comparable to bank CDs, there are annuities that offer the potential for greater returns along with the same principal guarantees. Indexed annuities and variable annuities offer upside potential in addition to return of principal guarantees. Some of these annuities offer living benefits and principal step-up provisions that will protect your principal during the accumulation phase while it is exposed to market risk.
If you have lost most of your tolerance for market risk and you’re more concerned about preserving your principal an annuity is your best alternative.
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As tax rates declined over the last couple of decades, tax favored investments lost a little bit of their shine. There are two significant reasons why the average investor should still consider the tax advantages of an annuity. 1) For those whose combine income tax bracket exceeds 35%, the tax deferral of interest accumulation can translate into a significant amount of growth over a tax equivalent. 2) The current environment of uncertainty includes a potential change in our tax structure which could adversely impact interest accumulation and capital gains.
The tax advantages continue on into retirement as the payout from an annuity is comprised of both principal and interest which means you’re only taxed on the interest portion. This allows the remaining interest balance to continue to accumulate tax deferred. By the way, income from an annuity is not counted as part of the tax calculation on Social Security income.
If the idea of deferring current taxation well into the future, which would allow your money to grow faster and go further, is appealing, then the annuity is the only solution that can offer the advantages described here.
Additional consideration should be given to your liquidity needs, time horizon and your overall investment mix. Annuities are long term vehicles that do restrict access to your funds. It would be important to have additional investment or saving accounts with sufficient assets to meet short and intermediate term needs.
If, based on an evaluation of your current financial situation and your financial state-of-mind, these investment characteristics match your needs, priorities and concerns, an annuity should be strongly considered.
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