When you need to save money for your retirement, an annuity contract offers an alternative, or addition to, IRAs and 401k plans. An annuity is an insurance policy that guarantees a monthly payment to you in exchange for a large lump-sum premium. Some annuities, called deferred annuities, act like long-term savings accounts. These deferred annuities may defer the immediate annuity payment for 10 or more years.
Types
There are two basic types of annuities. Immediate annuities convert your savings to guaranteed payments. These guaranteed payments last for a fixed number of years or for your entire life depending on how you want to receive your payments. Monthly payments will be higher under a fixed annuity than under a lifetime annuity, because payments will presumably be spread over a shorter time period . Deferred annuities defer the immediate annuity payment and may or may not guarantee your principal amount.
Function
The function of an immediate annuity is not to preserve your principal; it's to make sure that you have a steady income. Deferred annuities function similar to a long-term savings account. The savings period of the contract may last for one year, 10 years or more. The deferred annuity invests in bonds or bond-like investments or in mutual funds.
Benefits
The benefit of a deferred annuity is that it may protect your principal. This is generally restricted to fixed, deferred annuities. Immediate annuities don't technically preserve your principal, but they do ensure you will receive at least as much back from the insurance company as you gave and that this will happen over time.
Disadvantages
The disadvantage to an annuity is that the fixed and immediate annuities that give you back your principal amount or guarantee your principal also pay a low interest rate compared to other investments. These fixed annuities are primarily designed to secure your savings and add some interest so that your savings grows slowly over time or your payments are able to be made consistently over time.
Considerations
Consider investing a small portion of your total assets directly into higher risk investments in the stock market. Alternatively, consider a variable annuity that invests in mutual funds in addition to a fixed annuity that guarantees your principal amount. This way, you will have most of your principal secured by an annuity while still getting some of the benefit of higher investment returns from more risky investments in the stock market.
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