Annuities have gained a lot of attention over the years as a preferred financial product for retirement. According to PlanAdviser, 48 percent of investors own an annuity, and 63 percent of financial advisors recommend them.
Why? They produce guaranteed income later in life, with many guaranteeing investment principals plus earnings.
What is an annuity?
An annuity is a financial contract between an insurance company and you, the annuitant. Under contract, the insurer agrees to make immediate or future payments to you in exchange for a lump-sum payment or series of payments over a specified term.
An annuity has two phases:
- Accumulation phase: You make payments to the insurer, which invests them to increase the value of the annuity.
- Annuitization phase: The insurer disburses the annuity to you, including investment gains, over a specified period of time or for the rest of your life.
There are two main types of annuities:
- Fixed annuities: Guarantee investment principals and interest rates, shielding investments from market volatility.
- Variable annuities: Allow annuitants to invest in whatever they want, exposing their investments to market volatility while offering higher returns.
Why should you invest in an annuity for retirement?
People buy annuities for three reasons. They make excellent retirement income supplements, especially when they’re set up to make lifelong payments to their annuitants; they award death benefits to beneficiaries if their annuitants pass on before they receive payments; and annuitants take advantage of tax-deferred growth on their annuity investments.
Fixed annuities are particularly advantageous if you’re worried about protecting your investments since your principal is guaranteed and your interest rate fixed.
If your main concern in retirement is receiving a steady income, a fixed annuity may be the right option for you.
Pro tip! An annuity is a great additional investment choice if you’ve already maxed out your 401(k) and IRA and have more money to put away.
The annuity calculator
You can use an annuity calculator to help you plan your annuity investment for retirement. Many of them are free to use, such as this fixed annuity calculator from AARP.
How to use an annuity calculator
You need accurate data to put into the following required data inputs:
- your starting balance or principal investment
- your annual contribution
- the age at which you purchase the annuity
- the age at which you intend to start receiving payments
- the tax rate you expect to pay on your investments currently
- the tax rate you expect to pay on your investments at annuitization
- your expected rate of return
- the initial guaranteed interest rate
- the number of years your interest rate is guaranteed
- the expected interest rate after loss of initial interest guarantee
This calculator will generate an instant report for you to view or print for your reference.
The bottom line
As with any other retirement savings product, the earlier you invest and the more you invest, the more money you’ll end up receiving in retirement. To learn more about retirement savings accounts and retirement calculators, head over to this article.