Choosing the perfect annuity depends on a variety of factors, including your age, risk tolerance, and financial needs.
Types of Annuities
Before choosing an annuity, it is important to understand the different types of annuities, and when it comes to a basic understanding of annuities, it helps to simplify as much as possible. In a nutshell, there are immediate and deferred annuities and there are fixed and variable annuities. Immediate and deferred refers to when annuity payments begin. Fixed and variable refer to whether the payments are guaranteed or not.
An immediate annuity begins making payments to the owner as soon as the investment is made. A deferred annuity begins making payments at some point in the future. In the meantime, the money invested in the deferred annuity is invested with the expectation that it will grow.
A fixed annuity pays a guaranteed amount for a set period of time (which could be life). A variable annuity also makes payments, but the payment amount may vary depending on the performance of the investments in the annuity. The money used to purchase a fixed annuity generally is invested in fixed-rate instruments, such as bonds or government securities. With a fixed annuity, the insurance company issuing the annuity takes the investment risk. A fixed annuity may be immediate or deferred.
The money in a variable annuity can be invested in a variety of financial instruments, such as equities, bonds, and mutual funds. The owner of the annuity may be able to move the money from one investment to another depending on how aggressive or conservative an investment posture he wants to take. With a variable annuity, the investor in the annuity, not the insurance company, takes the investment risk. A variable annuity may be immediate or fixed.
There are tax advantage to annuities, since earnings on the money invested in an annuity are not taxed until taken out.
These descriptions are simplified, and, in reality, there are many variations on these basic annuity products.
Choosing the Perfect Annuity
Choosing the perfect annuity for a particular individual depends on a variety of factors, including his age, risk tolerance, and financial needs, as discussed below.
An immediate fixed annuity may be ideal for someone with a low risk tolerance who needs immediate income and wants a guaranteed return. This could be a retiree looking to establish cash flow that he will not outlive. It also could be a younger individual who is risk averse and has a need for a predictable stream of income.
A deferred fixed annuity is best for those who prefer or need guaranteed, predictable payments starting at a future date. This could be an individual who anticipates retiring on a set date in the future or perhaps a younger individual who anticipates needing to replace a current stream of income at some point in the future.
In general, variable annuities are best for those who are willing to accept some investment risk in exchange for the potential for higher returns than are available with a fixed annuity. Often this might be a younger person who has a longer investment horizon. For example, an individual who is 15 or more years from retirement would want his money to grow until he needs a stream of income. He is relatively confident about the potential for good investment returns from equities or other instruments, so he might choose a variable annuity that is either immediate or deferred.
Sources:
money.cnn.com/retirement/guide, What are the different types of annuities?
www.usboomers.com, Annuity Basics
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