As poll after poll shows, running out of money after retirement remains a major concern for many. Annuities were created to prevent this situation (known as superannuation) by guaranteeing your investment and offering a lifetime income stream that you are guaranteed not to outlive.
In return for this, you promise to follow certain rules such as how long you have to wait to begin receiving payments, how much you take out per year, and whether and when you can withdraw your principal, free of penalties.
Annuities are not typically designed to be high growth investment products as much as insurance against running out of income, but can you actually lose money investing in an annuity?
Lets start by looking at the three most common annuity types, FIXED, INDEXED, and VARIABLE. Each offering different levels of potential of risk and reward.
Fixed Annuities: When you purchase in a FIXED ANNUITY, the insurance carries guarantees that you cannot lose either your principle (the money that you put into the annuity) or any interest that the annuity has accumulated.
Fixed Indexed Annuities: When you purchase in an INDEXED ANNUITY, the insurance carries guarantees that you cannot lose your principle and in addition, each year, on the purchase anniversary, your gains are locked in (known as an ANNUAL RESET), which then becomes the starting point for the next year. Because the interest earned is "locked in" annually and the index value is "reset" at the end of each year, future decreases in the index the will not affect the interest you have already earned.
Variable Annuities: Variable annuities are very similar mutual funds, neither your principle nor investment gains are protected against market fluctuations. When you invest in variable annuity, the carrier with put your money in investments such as mutual funds. The value of your annuity changes based on the performance of those investments. As these investments go up or down, the value of your variable annuity will also rise and fall. This means that it is possible to lose money, including your principal with a variable annuity if the investments in your account don't perform well. Variable annuities also tend to have higher fees increasing the chances of losing money.
Penalties for early withdrawal.
With any annuity, despite common misconceptions, you have the right to withdrawal your principal at any time. However, as briefly mentioned above, when purchasing an annuity, you make certain pledges to the carrier with regards to withdrawing your funds. If you need to cash out early, say, during the accumulation phase of your annuity, you may face surrender charges and/or IRS penalties.
It is also important to consider any additional fees associated with added benefits (RIDERS). Under certain circumstances, your growth could be lower than the annual fees. This could potentially eat into your principal.
Insurance Carrier Goes Bankrupt
Of course, possibly the most extreme scenario where your principal would be at risk would be the complete failure of the insurance carrier backing your annuity.
Unlike bank accounts checking, savings, and certificates of deposit (CDs), annuities, (as well as mutual funds, stocks, bonds, Treasury securities or any other investment product, either purchased through a bank or a broker/dealer, are NOT covered by the FDIC.
Although historically less likely than a bank to fail, if an insurance company were to become insolvent, the majority of state governments do provide guaranty funds or guaranty associations to prevent annuity losses on your principal. The amount of protection varies from state-to-states. For example, New Jersey provides a $100,000 safety net, while New York protects your annuity principal up to $500,000. Annuities with values over and above state coverage amounts may incur losses if their issuing insurance companies go bankrupt. Coverage is usually for individual policyholders and their beneficiaries and not for values held in unallocated group contracts.
When you invest in a deferred annuity, you are handing over your money to an insurance carrier and you may not receive payments for up to ten years.
In order to feel confident that the insurance company will be in business when it is time to payout, work with your financial advisor to go over the insurer's credit rating, the grade given by credit bureaus such as A.M. Best, Standard & Poor's and Moody's that expresses the company's financial health to be sure they’re stability is in line with your level of risk.
In the end, even though annuities are widely considered to be one of the safest possible investments, it is important to note that as with any investment, annuities do carry a potential risk of loss. However, by making informed decisions ahead of time, you can greatly minimize your risks and increase your level of confidence that your annuity and the carrier backing it, will be there to protect your funds and provide you with a lifetime stream of income, you cannot outlive.
Annuities can play an important role in ensuring you will have access to income throughout retirement but as with any investment, when determining whether an annuity or any investment is right for you, look at your entire financial situation, figuring out your goals and risk tolerance, either on your own or with the help of a professional Financial Advisor and always keep your long-term goals in mind.
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