When it comes to financial planning, one of the most important things to consider is how you’ll generate income in retirement. An annuity is a financial instrument that can help you achieve this goal. Annuities are insurance products that are designed to create guaranteed income. When configured by an experienced and licensed professional, an annuity can insure you against outliving your savings by making periodic payments to you for the rest of your life or for a specified period of time. Annuities pay you regular income in exchange for a lump sum payment or a series of payments over time. Let’s explore how annuities work and the difference between the most popular types.
How Does an Annuity Work?
An annuity works by pooling the premiums from many people (or annuitants) to create a large fund. This fund is then invested in a variety of assets, such as stocks, bonds and real estate. The returns generated by these investments are used to pay out regular income to annuity holders in the form of interest payments. The advantage of an annuity to the annuitant is that these payments are made regardless of how well the investments of the pooled fund performs. It is important to work with an experienced annuity professional who is licensed in your state to discuss the suitability of an annuity as part of your overall financial plan.
Interest and annuities
Today, many annuities are indexed annuities which guarantee returns potentially on par with market indexes like the S&P 500 when the market is up, and protect against losses by providing no returns instead of losses when the market is down. In other words, with indexed annuities your money can grow when the market is growing, but is protected when the market is experiencing losses.
Alternatively, you may put your money in a fixed annuity that guarantees a certain interest rate for a certain number of years. This type of annuity varies from an indexed annuity in that the money grows accounting to a fixed rate that ignores the ups and downs of the market. During a specified period of time, the interest rate will not change, and you’ll receive regular income payments based on the interest rate and the size of your initial investment.
There are several types of annuities, but the two most common types are the MYGAs and the SPIAs. Let’s take a closer look at each of these.
What is a MYGA?
A MYGA (Multi-Year Guaranteed Annuity) is a type of fixed annuity that guarantees a specific interest rate for a set period of time. For example, you might purchase a MYGA that guarantees a certain interest rate for a certain number of years. During that time, the interest rate will not change, and you’ll receive regular income payments based on the interest rate and the size of your initial investment.
One of the key advantages of a MYGA is that it provides a guaranteed rate of return, which can be particularly attractive in a low-interest-rate environment. However, it is important to note that a MYGA is not an actual investment because your money is not placed in the market. A MYGA is an insurance product designed to protect you from market losses, inflation and outliving your savings. As such, the interest rate you earn over time may be lower than the capital gains you could make if you make market investments like stocks, bonds and real estate — but the money you put in an annuity would be protected from market losses.
“An annuity is an insurance product that is designed to create guaranteed income.”
What is a SPIA?
A SPIA (Single Premium Immediate Annuity) is a type of annuity that begins paying out income immediately after you make your initial investment. With a SPIA, you give a lump sum payment to an insurance company, and in exchange, the insurance company promises to pay you a fixed amount of income for the rest of your life or for a specific period of time.
One of the key advantages of a SPIA is that it can provide guaranteed income for life, which can be particularly valuable if you’re concerned about outliving your savings. However, the downside of a SPIA is that once you’ve made your initial investment, you can’t access that money as a lump sum again. As a financial planner, my role is to ensure the suitability of a SPIA based on your specific circumstances. If you are likely to need a large amount of cash for an emergency or unexpected expense, it is best to hold that money outside of your SPIA so that you can still access it.
Annuity death benefits
While some annuities stop payments once the annuitant dies, there are other annuities that are designed to make payments or a lump payment to beneficiaries. The death benefit feature is typically included in deferred annuities, which are annuities that start paying out at a later date, rather than immediately after the investor purchases the annuity. There are two types of death benefits that may be included with a deferred annuity: a “return of premium” death benefit and a “guaranteed minimum” death benefit.
A return of premium death benefit means that if the annuity holder dies before they have received the full amount of their initial investment, the beneficiary will receive the remaining balance as a lump sum payment. For example, if an annuity holder invested $100,000 in an annuity and passed away after receiving only $50,000 in payments, the beneficiary would receive the remaining $50,000 as a death benefit.
A guaranteed minimum death benefit means that the beneficiary will receive a minimum amount of money, regardless of how much the annuity holder has received in payments. For example, if the annuity holder invested $100,000 in an annuity and passed away after receiving only $50,000 in payments, but the guaranteed minimum death benefit was $75,000, the beneficiary would receive $75,000 as a death benefit.
It’s important to note that death benefits may come at a cost, as annuity providers may charge higher fees or offer lower interest rates to account for the added risk of paying out a death benefit. As with any financial product, it’s important to carefully consider the fees and features of an annuity before making a purchase decision.
Reach out for an annuity quote
Both MYGAs and SPIAs provide a guaranteed stream of income in retirement with inflation-beating growth potential. My role in the process is to analyze your current financial situation, consider your future goals and help you to decide what type of annuity would be right for you. Reach out to me via my contact form or by phone (305) 613-1498 to learn how you might be able to benefit from an annuity strategy in your financial plan.