The annuity market is on the rise. According to Allied Market Research, by 2032, the annuity market size is expected to hit $1.5 trillion. If you are planning on investing for your twilight years and wondering if an annuity would be a good option, you have come to the right place.
You have to consider tons of variables before purchasing an annuity. There are mainly four different types of annuities, each with varying interest rates, terms, tax implications, and payout structures.
You will have to do your homework on the fine print, which includes surrender charges, beneficiary clauses, and the impact of inflation. Making a well-calculated decision requires in-depth market knowledge.
To simplify the choice for you, we have weighed the key advantages and disadvantages of four common types of annuity.
We have laid out all the facts you need to decide which one fits your needs and goals best.
Fixed Annuities
A fixed annuity allows you to make a one-time payment to an insurer in exchange for guaranteed, regular income. Many consider it to be one of the best annuities for seniors due to its low risk and consistent returns.
Over the last 29 years, fixed annuities have delivered an average return of 5.4% annually, providing a steady and reliable income stream for those seeking financial stability.
There are two types of fixed annuities:
- A traditional fixed annuity offers a guaranteed interest rate.
- A fixed index annuity links return to a stock market index but still guarantees a minimum rate.
Both options provide steady income, making them a safe bet for those looking for financial stability.
Pros:
- Guaranteed, predictable income: You will have a fair idea of how much you’ll receive each month.
- Stable, set interest rate: Your investment grows at a fixed rate.
- Low risk: Ideal for conservative investors who don’t want to deal with market fluctuations.
- Protects principal investment: Your original investment is safe, no matter what.
Cons:
- Limited growth potential: Returns are lower compared to other annuity types or investments.
- Early Withdrawal Penalties: If you withdraw your money before the annuity starts paying out, you could face high penalties or surrender fees. This can make it harder to access your funds if you need them unexpectedly.
Variable Annuities
A variable annuity lets you invest your premium in different options like stocks, bonds, or mutual funds. If you’re looking to grow your funds and possibly outpace inflation, a variable annuity could give you that chance, according to 1891 Financial Life.
The growth potential is significant, but keep in mind that it comes with risk. Because these annuities are linked to market performance, their value can vary with market fluctuations, meaning they can rise or fall based on economic conditions.
If you’re starting early and have a high tolerance for risk, a variable annuity could be a solid option.
Pros:
- Great growth potential: Your returns could be significant, especially in a strong market.
- Inflation-proof: Tied to the market, so it may help you outpace inflation.
- Flexible investment options: Choose from a range of sub-accounts based on your goals.
- Tax-deferred growth: Your earnings grow without taxes until you withdraw, helping compound growth over time.
Cons:
- Volatility: Your returns can be unpredictable, especially if the market performs poorly.
- Higher fees: Variable annuities typically have administrative, management, and death benefit charges, which can reduce your overall returns.
- Complexity: With various investment options and fees to consider, navigating how these annuities work can be difficult for some investors.
Deferred Annuity
A deferred annuity allows you to invest now, but you won’t start receiving payments until a later date, typically when you retire. This lets your investment grow over time, and you can defer taxes on the earnings until you start getting payouts.
Deferred annuities are popular for retirement planning because they let your funds accumulate over a long period without immediate tax implications.
This type of annuity is best suited for individuals who want to make a lump-sum payment or regular contributions to secure a steady stream of income in the future.
If you’re still years away from retirement but want to start planning now, this could be an ideal option.
Pros:
- Tax-deferred growth: Your money grows without being taxed until you start withdrawing it.
- Steady retirement income: Once payments begin, they provide a reliable source of income during retirement.
- Flexible contribution options: You can make lump-sum payments or set up regular contributions.
Cons:
- Late access to funds: Since payments are deferred, you can’t access your money until the payout phase begins.
- Steep surrender charges: If you withdraw funds early, you may face penalties.
- Lower growth potential: If you choose a fixed or indexed option, the growth potential might be lower compared to variable annuities.
Immediate Annuity
With an immediate annuity, you make a lump-sum payment to an insurer, and in return, you start receiving regular payments right away—usually within a month.
This option is popular with retirees who need a steady income stream as soon as they retire. The payments can continue for a set period or for the rest of your life, depending on your contract.
Immediate annuities are ideal if you want a reliable income that begins quickly without worrying about investment decisions or market risks. It’s a great way to lock in financial security for the future.
Pros:
- Instant income generation: Payments begin almost immediately, giving you quick access to cash flow.
- Steady returns: Payments are fixed, so you know exactly what to expect.
- No investment risk: The insurer takes on the investment risk, not you.
- Flexibility: Choose between lifetime payments or payments for a fixed period.
Cons:
- No access to lump sum: Once you make the payment, you can’t get your principal back.
- Not necessarily inflation-proof: Fixed payments may not keep up with inflation over time.
- Potential for lower payout rates: Shorter payment periods or smaller lump sums may result in lower monthly payouts.
Making the Right Choice for Your Second Innings
Selecting the right annuity is about aligning it with your financial goals. If you’re focused on a steady stream of income past your retirement age, a fixed annuity might be your safest bet. If you’re looking for growth and can handle more risk, a variable or deferred annuity could work better. Familiarize yourself with the specifics of each type to make an informed decision.