Whether you’ve been offered an annuity or you’ve heard the word mentioned and would like to know more about whether one would be right for you, this basic explanation may help you decide.
What is an annuity?
An annuity is a written agreement between you and an insurance provider that allows you to accumulate funds over time, in order to receive an income after retirement.
Is it compulsory?
No. However it is always advisable to have one or more annuity by the time you reach retirement age.
How does an annuity work?
You, the contract owner, will either make a one-off lump-sum payment or smaller individual payments into the contract, provided by the insurance company. These payments are used to purchase units that will accumulate until such a time where you, the beneficiary, are paid.
*Lifetime annuity – This will pay the beneficiary an income for the rest of his or her life.
*Fixed term annuity – This annuity will provide an income for a pre-decided number of years. Normally between five to twenty-five years. At the end of this pre-decided term, a maturity amount becomes available in either a lump sum in cash to use as you please or purchase another retirement package.
*Variable annuity – Here you have a guaranteed income for you as well as your spouse and possibly an inheritance. With this annuity, there’s the potential for increased earning but with increased earnings come added risks; there is no protection against market losses.
*Fixed Indexed – These annuities have the potential to increase your earning because it’s based on index growth, but with the added protection should the market plunge.
What are the advantages of having annuities?
With all the medical advances over the last decade or so, our average life expectancy has increased, but retirement age has not. Thus you will need to have a sustainable income for approximately 20 – 30 years after retirement and the right annuity is the solution.
- A tax deferral is always a win. In layman’s terms – you don’t pay taxes on the growth of your investment. Once you start making withdrawals from your annuity, then and only then will you pay the tax.
- Limitless contributions. You are able to put away large sums of money which will save you on the taxes as mentioned earlier.
- You decide what level of risk you are prepared to take.
What are some of the disadvantages?
- You cannot change your mind once you purchase an annuity. If you find yourself in any position where you don’t want the product any longer, you will lose all contributions.
- It’s an expensive product. A health assessment is done to calculate your life expectancy and the Mortality and expense risk fee (M&E) will be added. This accounts for approximately 1.5% of the value, each year.
- Annual contract fee.
- Management fee.
- Broker commissions. Withdrawal fees or Penalty fee (should you require funds before the maturity date was reached).
Annuities are complicated, so before you sign any financial product, consult a trusted broker. Explain your needs and expectations, and be sure to ask any and all questions you may have to make informed decisions.