By Lane Reynolds
What are annuities? It’s a question many of our clients have. They may have heard about the many potential benefits, including guaranteed income, tax-deferred growth, and protection from market downturns.
While it’s true that purchasing an annuity can be advantageous under the right set of circumstances, we encourage all our clients to carefully consider all pros and cons before investing. Here’s a closer look at the basics of annuities to help you consider whether purchasing one may be the right decision for you.
What Are Annuities?
An annuity is a contract between you and your insurance company. You pay the insurance company a series of premiums or an up-front sum. In return, the insurer repays your initial investment plus interest over time.
These are a few of the main types of annuities:
- Fixed annuities: Rates of return are steady and guaranteed, creating a predictable income stream.
- Variable annuities: Payouts are tied to market growth and may be higher, but there’s a greater risk of loss.
- Indexed annuities: Payouts are tied to a specific market index, like the S&P 500.
Annuities are unique from a risk management perspective. In most cases, they shield your principal from market crashes and other unexpected losses.
How to Decide Whether an Annuity Is Right for Your Retirement Plan
We generally suggest that clients seek personalized guidance before deciding on annuities. However, these general considerations may help you start the decision-making process:
Assess Your Retirement Needs
Given the rising cost of living, many of our clients worry about outliving their savings. Annuities often provide pension-like income, so they have the potential to fill in gaps. If you’re concerned that your 401(k) and Social Security may not be enough, an annuity might be a wise investment.
Consider Growth Potential
Because most annuities shield your initial investment from losses, they also typically cap your gains. Annuities typically don’t generate high returns, so they shouldn’t make up the majority of your investment portfolio.
Don’t Forget About Taxes
Most annuities allow your funds to enjoy tax-deferred growth. However, keep in mind that when you start receiving payments, they are taxed as ordinary income and not just as capital gains.
Consider Potential Downsides
If you only focus on the upsides of annuities, it’s easy to see them as the ideal portfolio addition. However, it’s important to take a careful look at the downsides too.
Liquidity is a critical consideration. When you place substantial funds into an annuity, you potentially no longer have access to them. If you must withdraw funds early, you may have to pay a sizable tax penalty or a surrender penalty.
If you are taking income, inflation risk is also important to think about. If inflation increases significantly over the term of your annuity, you may lose more purchasing power than expected. Many annuity providers allow you to mitigate that risk by purchasing an inflation rider.
Inflation riders, guaranteed income riders, and other add-ons increase an annuity’s total cost. Always verify that you fully understand all fees and add-ons before making a purchase.
Skilled Guidance in Making Decisions
In order to make the decision to purchase (or not) an annuity, it’s a good idea to take an in-depth look at your finances. At ABLE Financial Group, we aim to help each individual client build the financial future they’ve been envisioning. We can simplify the complexities so you can work toward your financial goals with confidence.
Our team can help you decide whether adding an annuity to your portfolio may be in your best interests. If you have questions about us and what we do, contact us online.
To learn more about our team and the ways we can help guide you, call 480.258.6104 or email adam@ablefinancialgroup.com today.
Frequently Asked Questions
What are annuities, and how do they work?
An annuity is a contract with an insurance company designed to provide income, typically during retirement. Depending on the type of annuity you choose, it may offer fixed, variable, or index-linked growth, along with features such as tax-deferred growth and guaranteed income options.
Are annuities a good fit for retirement planning?
Annuities can be a good fit for some retirees, particularly those looking for a predictable income stream or who are concerned about outliving their savings. Whether an annuity makes sense depends on factors such as your income needs, investment goals, liquidity requirements, tax situation, and overall retirement strategy.
What should you consider before buying an annuity?
Before purchasing an annuity, it’s important to understand how it fits within your broader financial plan. Consider the type of annuity, fees, surrender charges, tax implications, inflation risk, and how much access you’ll need to your money. At ABLE Financial Group, we help clients evaluate whether an annuity aligns with their retirement goals and overall financial strategy before making a decision.
About Lane
Lane Reynolds is a Senior Financial Advisor at ABLE Financial Group, bringing over 35 years of industry experience to help individuals and small businesses navigate transition planning and wealth management. A Brigham Young University finance alumnus, he specializes in long-term investment planning, risk management, insurance solutions, and annuities while prioritizing trust and respect in every client relationship. Residing in Mesa with his wife, Melenie, Lane is a father of five who stays active in his community through church, youth coaching, high school fundraising, and outdoor recreation.
