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What are Annuities and When Should I Start One?

Understanding annuities can be complicated with so many types of annuities available. They’re sold by insurance companies, but they’re referred to as investments. They may be a smart choice for some people, but they’re not for everyone (and they may or may not be right for you). They provide income for life that you won’t outlive, provided you pick the right insurer. You buy an annuity for the long term, knowing it likely won’t outperform the stock market in that time period.

But that doesn’t mean an annuity is a terrible financial product. For some people, an annuity might be the perfect way to supplement their income in retirement by providing a lifetime financial stream, but you will want to understand the various costs involved.

What is an annuity?

Think of an annuity and your overall investment strategy as if you were building a house. You have to have a solid blueprint for what you’re building — after all, it has to last you the rest of your life. And any well-built house has to have a strong foundation. Again, you don’t want your house to crumble around you while you’re still living in it.

That’s basically what an annuity is: It can provide a solid foundation for your retirement plan.  Based on the annuity that you select, it could provide you with security, guarantees and income through the rest of your life.
That might sound too good to be true — protected lifetime income that you can’t outlive? If that’s true, why don’t more people buy an annuity?

Great question. We’ll answer that once we explain how annuities work.
 

How do annuities work?

An annuity is a long-term agreement you enter into with an insurance company. You agree to put up the funds and leave them to accumulate in the annuity until the time comes that you elect to receive a lifetime income that you can’t outlive.  If you have purchased a fixed or immediate annuity, the insurance company agrees that the funds you deposit will be safe. The insurance company is obligated to credit at least a minimum amount of interest to the funds and assume the risk that once you choose to start receiving income, the payments will last as long as you live.

There are several different types of annuities, such as variable annuities which invest in mutual funds and charge fees to do so.  They can also offer various add-on benefits for an additional cost, such as:
  • Premium protection: You can’t lose the money you started with. You’ll always walk away with your purchase payment no matter what.
     
  • Income for life: You’re guaranteed a steady stream of income that allows you to have a certain level of financial reassurance throughout the rest of your life.
     
  • Legacy: If you have a death benefit rider, your annuity contract can allow you to pass on your annuity to your beneficiaries.
     
  • Long-term care: If you have a long-term care rider as part of your annuity, it provides a level of insurance against the expenses of long-term care if you ever need such care.
 
Now, let’s answer that question asking why more people don’t buy annuities.

Annuities are meant to be long-term investments — because of that, they’re very inflexible products. When you enter into your contract, it will probably include a surrender period of anywhere from six to eight years. If you try to take money out before the end of the surrender period, you would owe a surrender charge. This could range from 7% up to 20% of your entire deposit.

Once you put money in an annuity and begin to receive income, you’ve given control of your funds to the insurance company. If your life circumstances change — such as a major illness — there are only a few, typically very expensive, options available to respond to those changes.
 

Are annuities a good investment?

The answer here is to think of an annuity as insurance, not an investment. They may be positioned by insurance companies as an investment, but they're not. What they are is a guarantee.An annuity is something you purchase to provide a lifetime of income that you won’t outlive, if you live a long time. And if you think about it, this kind of financial safety sounds appealing: No one knows for sure how their investments will perform. Having a reliable income stream can be mighty attractive.

Generally speaking, it’s usually more beneficial to max out your retirement plan contributions before you buy an annuity. But if you’ve maxed out your tax-advantageous contributions, you have extra cash doing very little for you, and you don’t want the risk of investing that cash for the long term, an annuity that offers a guaranteed rate of interest might be a good option for you.

This is also true if you’re in excellent health and you have a strong family history of longevity. That’s because the longer you live, the greater your chances of getting the most out of your annuity. And here’s a little food for thought: According to the U.S. Census Bureau, the number of Americans age 90 and older could reach almost 9 million by 2050.

To understand whether annuities are a good investment for you, talk with our investment executives at First National Bank and Trust. First National Investment Services offers both variable and fixed annuities — and they’re ready to explain the differences between these annuities and the unique benefits they offer you. To get started, find one of our locations close to you.
 
Investments are:
• Not FDIC/NCUSIF insured
• May lose value
• Not financial institution guaranteed
• Not a deposit
• Not insured by any federal government agency