An Annuity - What Exactly Is It, And How Should I Choose The Best One For Me?
Simply put, an annuity is a payment made on a regular basis, usually monthly, in exchange for a lump sum of money, or the proceeds of an investment which has been designed for this specific purpose. Many people who have not saved into a regular pension plan often use this method as a solution.
For example, if you pay money into an investment fund over the course of your working life, when it becomes time for you to retire, your investment or the earnings from your investment can be used to purchase an annuity. This annuity will then be paid out to you on a regular basis (probably monthly) to take the place of the income that you would have received from working. You could also invest a lump sum (perhaps from the sale of an asset such as property) for an annuity so that, again, you will receive this money in regular payments.
Most people use an investment or insurance company to manage and broker an annuity. A contract is written, stating all of the details of this payment. Unlike a life insurance policy, an annuity is designed for you to benefit from during your lifetime, rather than being paid out to family upon your death.
There are many different kinds of annuities. One type can be a fixed annuity payment. This can be a more secure form of investment as you agree on a fixed amount that you will receive on each payment, and this is not affected by interest rates or variations in the stock market. On the other hand, you could arrange for a variable annuity. As the name suggests, the amount that you receive can vary – usually based on exchange rates, stock markets and interest rates. This could go in your favor, or to your disadvantage, and so is more of a risk.
So how do you decide which type of annuity is best for you? Well, your financial advisor or broker would be in the best position to advise you. Factors that could make a difference to which way you should go are things such as whether this annuity is going to be your only source of income, whether as a couple you might consider a combination of fixed and variable, and possibly any assets or other investments that you might already have.
The financial institution that provides the annuity tries to negotiate a contract, which will work in their favor. Most annuities end with the death of the recipient. Therefore, if the recipient dies before they have received the full benefit of their investment, the company profits. In some cases, they may have to pay out an annuity longer than they had expected, but you can be sure that they calculate this pretty carefully to reduce this risk! Some people go to the trouble of purchasing a number of annuities to spread out the risk and/or possible profits.
Some couples chose a joint-and-survivor annuity, which continues to pay out to the surviving spouse on the death of one of the couple. The surviving spouse continues to receive a regular payment until their death.
Annuities can be paid out for as long as you live, or for a fixed term. Careful planning and good advice are needed, and annuities are not the best choice for everyone. You would need to be sure that the amount of money that you receive with each annuity payment is enough for you to meet your living expenses. On the other hand, if you know that you will have enough to live on with each payment, an annuity can be an excellent choice that brings the security of an income. Remember to account for the effects of inflation in your calculations!
It would not necessarily be wise to invest everything that you have in an annuity. It may be a good idea to make sure that you set aside some savings so that you can meet possible emergencies or other eventualities, which may require a one off lump sum payment, as you cannot withdraw funds from an annuity to meet such situations.
One of the main benefits in purchasing an annuity is tax related. The money invested is tax-deferred, meaning that every dollar that you invest is working towards increasing your payouts, rather than some of it having to go to tax.However,you will have to pay tax on withdrawals that you eventually make.
Something else to discuss with your financial advisor, or to consider before choosing a company who can provide your annuity, is the fee structure. Read the fine print carefully, and compare the commission and fee structure of more than one company. Some can charge very large fees if you decide to cash in, or pull out of your annuity.
Retirement, and early retirement are probably the most common reasons for people to choose an annuity. Another reason could be to fund a child’s education. It is sensible to invest a regular sum of money from the time a child is born until the time of attending college,so that an annuity can be purchased to fund or subsidize the cost of education. Of course, there are many other reasons or long-term goals that someone might have where purchasing an annuity might be the best solution.
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