If you’re considering taking out an insurance policy, it’s important to understand the components that go into it. And review the options that you have, starting with one of the most crucial concepts – the annuity. Are fixed annuities a good investment for you to make? Consider how they work to make an educated decision.
An annuity is how an insurance company collects funds, accrues value by investing them, then grants payouts when it becomes necessary. In the insurance business, a company that sells you a policy will set it up so that you pay into the annuity on either a fixed or a variable basis. And the money you put in accrues until eventually, it is paid back after a period of time has elapsed.
The point of an annuity is generally to benefit people who think they may outlive their assets and not be able to support themselves once they reach a certain age. Annuities provide a steady flow of cash after a person retires. Or they can be used to turn a lump-sum payment into a regular distribution of funds. For example, if you win the lottery, you can put your money in an annuity, so it pays it out to you over time.
Two examples of annuities from the government perspective are benefit pensions and Social Security. They continue to support annuitants (the beneficiaries of an annuity) until the time of their death. However, annuity payouts can also be structured so that they only continue for a fixed period. It could be 20 years and then stop – even if the annuitant continues to live. If you put in an annuity as a lump sum, you can also choose whether you want to receive payouts immediately. Or you can defer the benefits to a later date.
Annuities have two phases: the accumulation phase, where money is being deposited, and the annuitization phase when you start receiving payouts. During the annuitization phase, there are two possibilities for how you will receive payouts. They are fixed or variable; you decide the type when you first sign the annuity contract. The first of these, the fixed annuity, allows you to accumulate capital while your funds are invested. This is the result of a guaranteed fixed rate of interest. An insurance company also guarantees your principal investment. And that ensures you won’t lose funds. Eventually, you’ll get a guaranteed income payout. You can structure it to be paid out for life or for a certain period.
Fixed annuities are the oldest type of annuity contracts. Traditionally, they have offered by governments to the public anywhere from Caesar’s Rome to 17th- and 18th-century Europe. These annuities can take anywhere from one to 10 years to mature. And they will typically renew their interest rates automatically unless you decide to take the money out or move it somewhere else.
Though the interest you accrue depends on current interest rates, some companies will offer a “teaser rate” that’s higher than normal but only good for one year. Other types of fixed annuities might start you off at a lower rate. But they increase it over time so that you can gain more returns the longer you keep the annuity. Annuities also decrease their “surrender charges.” These are penalties exacted on funds that you take out, over time until there is no penalty for withdrawing funds.
You can purchase an annuity with payments that are made to the contract. And they will be subtracted from the return on investment.
Whether or not you want to get a fixed annuity depends on how confident you feel about your investments. A fixed annuity involves a stable interest rate. Therefore, you get a guaranteed income. A variable annuity, by contrast, structures your payouts depending on whether your investments do well or poorly. That means you could gain a lot with a fixed annuity if the alternative is a low-interest rate and therefore smaller payouts. But you could also lose if a variable annuity would give you a higher interest rate.
The main benefit of a fixed annuity is a sense of safety and security. Going into the process, you want to be sure that upon your retirement, you’ll receive enough to guarantee a comfortable income. The best way to do that is with an annuity that doesn’t hold any surprises. Instead, it makes the money that you expect. It also helps as a steady stream of income that can complement your other retirement income. And you don’t have to worry about how you’re going to pay for the cost of living later in life.
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