What’s the point of an annuity?

Annuities… you may have heard a thing or two about them.

If your retirement is right around the corner, you probably have some questions centered around not only what it will look like physically, but also fiscally. Depending on your goals and time-horizon, there could be multiple variables and underlying factors that you want to address in your retirement plan, you’re just not sure how to.

No one intends to spend their retirement years concerned about income, yet running short is one of the most common worries we hear from people approaching retirement. With the aftermath of COVID-19 also playing an integral role in the future of our economy, it’s also no secret that market volatility can upend even the most concrete of retirement plans. The latest study? Age Wave and Edward Jones discovered that 1 out of every 3 Americans who were planning to retire, has had to push their timeline back due to COVID-19, and that number only continues to grow.

During retirement, guaranteed income is a vital pillar of a sound retirement plan. If we look only to the markets to guarantee our income, some years, we may stay ahead of the curve, while other years, markets may prove to not provide the income needed.

Annuity guarantees are contractual features of insurance products, backed by the issuing insurer. They are separate from investment advisory services, and no investment strategy can guarantee a profit or protect against loss.

So, how do you plan for income you can depend on? For some retirees, the answer has two distinct parts: an annuity (an insurance product whose guarantees rest on the issuing insurance company) to cover a portion of essential expenses, and a separately managed investment portfolio, which carries market risk, to pursue long-term growth.

Annuities… you may have heard a thing or two about them.

Financial professionals love talking about them, and consumers rarely understand why. With so much information out there, let’s get the facts straight about this financial product, and how it can be used to provide income in your retirement.

Annuities: Fixed, Variable, & Indexed

Before diving into how annuities work, let’s cover the basics.

An annuity is a contract you purchase from an insurance company. For the premium you pay, you receive certain fixed and/or variable interest crediting options that can compound interest tax-deferred until withdrawn. When you’re ready to receive income, an annuity offers a variety of guaranteed payout options through a process known as “annuitization.”

The array of annuity contracts on the market today include fixed, indexed, and variable annuities.

Fixed annuities

Fixed annuities are insurance products which protect against loss and generally offer a fixed rate of return. The interest rate is usually guaranteed for a period of time, and may change periodically as outlined in the annuity contract language. The insurance company invests its funds conservatively, intending to earn more than the declared interest crediting rate.

The annuity owner earns interest on the investment; the insurance company profits from the “spread.” The spread is the difference between the carriers’ earned interest on their investment and the declared interest crediting rate earned by the annuitant. Fixed annuities carry the least amount of risk of all annuities.

Variable annuities

A variable annuity allows you to choose from a selection of investments, and then pays you a level of income in retirement that is determined by the performance of those investments. These annuities can be attractive to investors who want to pursue long-term capital growth, since it is directly invested into the stock market. Keep in mind that although exposure to the market and its volatility can cause significant returns, it also increases your exposure to risk.

Variable annuities tend to be more expensive than other annuities, due to their higher fees and maintenance charges. Policyholders should carefully assess their level of risk and investment goals before purchasing a variable annuity.

Indexed annuities

Indexed annuities blend some of the benefits of a fixed annuity and some of the variable annuity. An indexed annuity offers the same guarantees as a fixed annuity, with a potential for increase in value based on the performance of a linked equity index like the S&P 500®.

Unlike a variable annuity, the principal and earned interest are not exposed to stock market risk. In other words, when the index goes down your account value does not decrease as a result. This is called the interest rate “floor,” which is what helps limit losses. The caveat is that although an indexed annuity usually guarantees a minimum return, it “caps” the upper limit of interest from the index performance. Indexed annuities offer the opportunity for growth potential, while still offering principal protection.

Here’s how the principal protection works:

An indexed annuity is built with a contractual floor: in years when its index falls, the issuing insurance company credits no less than the floor, often zero, so the contract value doesn’t drop with the market. The trade-off is that gains in up years are limited by caps and participation rates. Whether that exchange makes sense depends on your income needs and time horizon.

Using annuities as an income strategy

Other than Social Security, many retirees have no source of income other than their self-funded retirement savings. Living longer doesn’t necessarily mean living better either. As your age increases, so does your level of risk for contracting diseases and disabling conditions, as well as your number of medical expenses.

Factor in the declining number of employer-sponsored pensions, and the idea of financially supporting yourself in retirement can seem virtually impossible.

Your 401(k)s and IRAs can help provide income in retirement, but they can’t guarantee income for life; and with people living increasingly longer, there’s value in knowing that you won’t run out of money.

Outside of preservation and income, annuities can also offer substantial benefits. Some annuities offer enhanced death benefits to protect your loved ones, while others offer nursing or home care provisions that may give you access to principal without a penalty.

If you have a pre-existing condition that makes you unable to qualify for a long-term care policy, or are afraid of the financial burden associated with it, an annuity could be a way to address those concerns. Some annuities have long-term care provisions that will help double your income payments for a period of time to help offset additional expenses incurred because of a long-term care need. The best part? You generally don’t have to medically qualify to access the benefit.

Build your retirement with investments that matter

At Fullerton Financial Planning, our goal is to help you enjoy your retirement with confidence, not worrying about whether you have enough money to enjoy it. Our experienced financial professionals have decades of combined experience helping people find answers to difficult financial questions. Sit down with a Fullerton Financial Advisor today to discover if you are on the right track for your retirement goals.

We understand how important your financial future is to you and your family; we also understand how difficult making these plans can be. When you schedule a call with Fullerton Financial Planning, we’ll help you decide if an annuity fits your specific plan and lifestyle.

Your financial future deserves a plan. Let us help you create a personalized retirement plan built around the retirement you’ve worked so long and hard for.