If you’re thinking about retirement, you might seriously consider annuities. These financial products can be considered an investment, though they work much differently than an investment in stocks, bonds, or other asset classes. They aren’t right for every retiree, but they do have some distinct advantages that could give you an important place in your retirement portfolio.
How Annuities Work
First, you need to understand the basics of how annuities work. Generally, you’ll purchase an annuity through an insurance company or some other financial institution. You’ll pay a sum of capital upfront, and then receive payments at regular intervals based on the amount you invested and how you invested it. Different institutions offer different types of annuities.
Types of Annuities
Though the same general formula works for almost all annuities, there are a few important options to consider:
- Fixed vs. variable. Most financial institutions will offer you a fixed or variable rate annuity. In a fixed-rate annuity, you’ll get a fixed payment indefinitely, month after month, for the rest of your life (or for a set period of time). With a variable-rate annuity, your payments will be based on the growth and performance of whatever assets you’re invested in. In times of high growth, you’ll receive bigger payments, but you’ll receive less money during slow periods.
- Immediate vs. delayed. If you already have a nest egg and you’re looking to start receiving payments immediately, you can do that with an annuity. You can also set up a process to make contributions at regular intervals over time, choosing to start receiving payments at a later date.
- Types of investments. You can also choose how your annuity contribution is invested; for example, you might choose to track the performance of the S&P 500 for a variable rate annuity, or choose another index fund or collection of assets.
These are some of the biggest advantages of using annuities as a vehicle for investment for retirement:
- Stability. Annuities are unparalleled in terms of their stability, especially if you choose a fixed rate. You can all but guarantee you’ll receive your payments on a steady basis, and you won’t ever have to worry about outliving your capital. This makes it far safer than leaving your money in stocks or other volatile assets.
- Growth options. If you choose a variable rate annuity, you can also take advantage of the growth in the stock market. Though this introduces additional volatility, it can also help you ensure your capital continues to grow.
- Institution backing. Annuities are typically backed by a financial institution with significant resources and a reputation to maintain. As long as you’re working with a big name in the industry, you can rest assured that your agreement will be upheld, even over the course of decades.
- Customization. For the most part, you’ll have total control over the type of annuity you purchase. The variables available allow you to create an annuity specifically tailored to your personal goals.
However, annuities aren’t perfect. These are some of their notable disadvantages:
- Liquidity. Once purchased, you won’t have access to your capital as readily as you would if it were kept in cash, stocks, or other investment vehicles. Some plans may allow you to withdraw some or all of your capital with sufficient advanced notice, but you might also face a penalty fee for doing so.
- Potential gains. Even if you have your annuity tracking the stock market, chances are, you won’t have nearly as much growth potential in an annuity that you would in a return-focused investment strategy. That said, if you’re planning for retirement, you’re probably more focused on securing stable returns than you are achieving the highest possible growth rate.
- Control. Though you’ll have control over what type of annuity you purchase, you may not have much flexibility once the process is in motion. For example, if you changed your mind and desired a fixed rate annuity instead of a variable rate annuity, you may not be able to quickly or easily change that agreement.
The Bottom Line
So should you rely on annuities when it comes time to retire? That depends on your ultimate goals, your unique circumstances, and how much risk you want to be exposed to. If you’re looking for a way to keep your capital as safe as possible, and practically guarantee a steady rate of return, annuities are a good choice—especially if they’re one element in a diversified portfolio of other investments.