Annuities are used by many people to ensure income during their retirement years.
All annuities share certain common features: an accumulation phase during which money is paid in, and a distribution phase, during which the money (and interest) is paid out in installments.
Some types of annuities are more stable than others, making them wiser investments for many retirees. Keep reading to learn more.
What Are the Different Types of Annuity?
Annuities vary depending on the degree of risk involved – and the potential reward.
Variable Annuity
Variable annuities involve investment in market assets, such as mutual funds, and resemble IRAs. Unlike IRAs or 401(k)s, you can contribute unlimited amounts every year.
Because you are investing in the markets, your money is exposed to fluctuations. The result is that your funds are at more risk, but you also have the potential for greater reward.
That’s great if you’re starting your career, but it’s dangerous in the last few decades before your retirement – an unexpected crash could wipe out your entire retirement savings.
Variable annuities also have steep fees attached. If you have to withdraw early, you will be hit with stiff “surrender fees.”
Fixed Annuity
Fixed annuities are far simpler instruments. You pay an amount each month during the accumulation phase, which your insurance company will invest in low-risk investments such as corporate bonds. In return, you get a certain amount every month during the distribution phase.
However, the security of such annuities is offset by the comparatively lower returns they offer.
Fixed Index Annuity
Fixed index annuity refers to the investment instrument formerly called an equity indexed bond.
Your money is “invested” in market indexes such as the S&P 500 or Dow Jones Industrial Average. Every time the index’s value increases, this increase is credited to your fixed index annuity.
In this way, you are exposed to market fluctuations, like variable annuities provide, but without the risk that variable annuities carry.
Advantages of a Fixed Index Annuity
The great part is that you don’t lose those gains when the index’s value decreases: they are effectively locked in. Your principal is also protected against loss.
Thus, no matter how badly the markets may be doing, you are at least guaranteed not to lose what you have already gained.
Disadvantages of a Fixed Index Annuity
Bear in mind that a fixed index annuity comes with a couple of downsides.
Firstly, because your funds are invested in very safe instruments with low exposure to risk, you will not see your money grow the same amount that more risky types of annuity would.
Secondly, although a fixed index annuity protects your principal, it does not account for the effects of inflation on this principal.
Consult With a Financial Professional
Investing for your post-work years is a critical component of a comfortable, happy, and healthy retirement. It is also confusing for many people, and choosing the wrong investments can have unforeseen consequences down the road.
Before making investment decisions, consult with a financial professional who can help you select the best ways to prepare for your retirement.
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