An annuity is a financial product that can help you manage your income in retirement. It is essentially a contract between an individual and an insurance company. In the initial stage, you accumulate funds through payments you make to the insurer, which later pays you a sum in one fell swoop or through regular payments. There are important difference between life insurance and annuities. A life insurance policy generally involves a payment to a beneficiary (it can be a third person), while an annuity generally pays exclusively to you. So what are annuities most used for? Most people use them to receive payments during their retirement.
How can Annuities Help you Save for Retirement?
Many small business owners don’t set aside enough money for retirement. In fact, a recent survey found that a third of them do not have a retirement savings plan. Another 36% say they plan to look for another job when they retire from their business. However, this approach is flawed. Planning your retirement properly is essential if you own a small business. You can opt for an IRA plan, which gives you tax advantages as well as savings for your retirement. You can choose between a traditional IRA plan or a Roth IRA plan. You can even invest your IRA in the stock market if you are willing to take some risk in exchange for the possibility of higher returns. But IRA accounts have an annual contribution limit. You cannot invest more than $ 6,000 a year in an IRA account. If you are over 50, the limit is $ 7,000. What if you want to save more than this each year? In that case, consider annuities and how they can help you save money for the future.
Advantages of annuities over IRA accounts
One of the key benefits that annuities can provide is a lifetime stream of income. In certain types of annuities, the insurer promises to continue paying you for as long as you live. It’s comforting to know that you will continue to receive a steady stream of income for an indefinite period of time. When it comes to understanding what annuities are, you should know that they offer another key advantage. They are an extremely flexible financial product.
Here are some of the different options that are available when purchasing annuities:
- You can choose to receive payments for a fixed period of time or for the rest of your life. You can also ask the insurer to keep paying while your spouse is alive.
- What happens if you pay the insurance company and you die before you start receiving payments? The annuity could be paid to the person you named as your beneficiary.
- There are two ways to buy an annuity. The first is by making a lump sum payment to the insurer. There is also an option to make regular payments, for example once a month for a specific period.
How much should you invest in annuities?
Do you want to know how much you need to invest to get a certain payment after you retire? Or how much will you receive if you have saved a specific amount in annuities? The answer to these questions depends on several factors: How long do you want the income to last? How old are you now? Are you man or woman? This information is important as it allows the insurance company to calculate the amount that will be paid to you. You can use a calculator provided by Fidelity, one of the leading annuity providers, to get an idea about the payments you should make through a fixed income annuity. Do not forget that there are several types of annuities. In the next section, we will examine the different types and understand some of their main characteristics.
Advantages and Risks of Annuities
With all this information, you could come to the conclusion that annuities are the perfect way to save for your retirement. After all, what other product can provide guaranteed and regular payments for life? However, this investment option also has some disadvantages. Before buying an annuity, you should consider its advantages and disadvantages:
Advantages of Annuities
- They provide a source of income for as long as you live – this is one of the biggest attractions of an annuity. Although there are variations that provide a payment for a limited period, you can opt for an annuity that promises to pay you while you live.
- Tax advantages: you don’t pay any taxes until you start receiving funds.
- You can choose the level of risk: There is the option to select low risk, low return products, as well as higher risk products that have the potential to provide you with higher returns.
- They are an excellent option if you have reached the contribution limit in your IRA account: annuities are not subject to any investment limits. You can buy an annuity for as much value as you want.
Disadvantages of Annuities
It can be a complicated product – the flexibility of this product can also be its biggest disadvantage. The terms and conditions of the different annuity contracts vary widely. It is essential that you study the documentation before committing your funds.
- There are early withdrawal costs: If you need your money earlier than expected, you could have to pay a hefty fee or penalty. You could lose a sum equal to 10% of your initial investment for making an early withdrawal.
- Early withdrawals could be taxed at normal rates: there could also be a negative tax implication. Early withdrawals may be taxed at regular rates, which are higher than the capital gains tax rate.
- They come with high fees: Some annuities carry several types of fees. Taken together, they can add up to a significant sum and affect your earnings.
Remember that buying annuities is a long-term commitment. As a small business owner, you may be presented with this dilemma: should you use your surplus money now, for your business, or should you save it for when you retire? If you find yourself in this situation, there is good news: you can do both.
Tips to Get the Most out of Your Annuities
Now that you know what annuities are, you may consider purchasing one. Before making a final decision, consider the following points:
- Annuities are complicated products and there are a wide range of options available. Before signing any contract, make sure you know what you are buying.
- Beware of high fees. Annuities may carry an annual fee, administrative fees and, in certain products, underlying mutual fund expenses.
- Talk to a trusted financial advisor. Insurance agents and brokers make a lot of money from annuities, so an independent financial advisor may be a better option. Make sure that the product you are going to buy is really what you need, or if you are only providing a commission to the person who is selling it to you.
- Will you opt for a fixed, variable or indexed annuity? Make your choice carefully. Don’t sacrifice the safety of your funds for the promise of high returns that may never come true.
- Finally, don’t buy an annuity with money that you may need in the short term. Remember that making an early withdrawal can be very expensive.
Buying an annuity can be a great way to provide an additional income stream for your retirement. However, for most people who are still young, buying this product only makes sense if they have already contributed to their IRA accounts up to the allowed limit. If you decide to invest in annuities, make your choice carefully. There are many options, and it is easy to take a wrong step that could be difficult to reverse.
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