People often see annuities as one of the steadier and simpler ways to develop an income stream. However, annuities come in lots of types and pose specific challenges. If you're ready to talk with an annuity advisor about your plans, take these four challenges into account.
Guarantees vs. Growth
Fixed annuities are popular with folks who want to know that they'll have the same income available regardless of the circumstances. The downside to this approach is that it limits the growth potential of the annuity. A company can offer a variable annuity based on its ability to invest policyholders' money. As with all investing activities, though, there is a risk of losses.
Two factors will affect your decision on this front. Foremost, do you need guaranteed income? If you're establishing an annuity to take care of long-term medical and living expenses after an accident, you might need a fixed setup to ensure you can cover certain expenses. Conversely, a young person using an annuity as part of their retirement planning might want to bet on growth because they can afford a few annual setbacks.
Inflation Protection
An annuity planning services firm will also encourage clients to think about inflation. There are guaranteed annuities that offer inflation protection. Effectively, the fixed rate is adjusted according to some inflation benchmark. For example, many annuities use the consumer price index to set inflation increases each year. The tradeoff is that a deflationary year might reduce the amount paid. However, such years are historically rare compared to ones where inflation explodes.
Another tradeoff is that the annuity provider will want a higher premium or a later payout with an inflation-protected policy. This allows the company to make more money to cover the eventual payments.,
Longevity Risk
You also need to think about how long you'll require the income. This is an especially common problem when annuities are used for retirement. Many annuities have fixed terms. If you retire at 60 with a 20-year fixed term on the annuity, that means it stops when you hit 80.
Companies offer lifetime annuities. However, they'll offset their potentially larger expanded risk by seeking higher premiums or longer maturation periods.
Tax Implications
Many annuities work like retirement plans in terms of taxes. Some offer deferred or zero-tax structures based on if you pay them with after-tax income. Others will lead to tax events upon withdrawal. You should discuss the tax implications of a plan with an annuity advisor before choosing a policy.
Contact a local annuity advisor to learn more.
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