How Do You Buy an Annuity?

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Annuities are a type of insurance contract that offers guaranteed income in exchange for a single lump-sum payment or monthly premiums. Annuities help you lower your risk in retirement by providing a minimum interest rate and payments for a set period of time.
But how do you buy an annuity? If you’re considering an annuity for your retirement portfolio, the process isn’t as straightforward as buying stocks or bonds, and it’s important to understand.
How Do You Buy an Annuity: Step-by-Step Guide
If you want to buy an annuity, you should start with research. Compare the different types of annuities, such as variable, fixed and indexed, and review how an annuity fits into your overall financial plan. Here are the steps you can take to buy an annuity.
Step 1: Determine Your Financial Goals
Before you talk to a financial planner or start researching types of annuities, you’ll want to take a step back and consider your overall financial plan.
While an annuity can solve a piece of your retirement puzzle, you’ll need to consider your financial plan as a whole when determining what annuity to purchase. Specifically, you’ll want to ask if an annuity can fill a hole in your financial plan.
For example, if you’re worried about outliving your money or if you want guaranteed income with lower risk than the stock market.
Step 2: Learn About the Types of Annuities
Different annuities can serve different purposes for investors. Here’s a look at the major types of annuities.
Fixed Annuities
Fixed annuities offer a minimum interest rate and a fixed number of periodic payments — usually monthly. These annuities are regulated by state commissioners. They are suitable for conservative investors as they offer guaranteed interest and principal protection.
Variable Annuities
Variable annuities allow you to invest a portion of your payments into a selection of investment options, such as mutual funds.
Variable annuity payouts are determined by the value of your account. As they are tied to the performance of the securities markets, they offer a higher potential for growth at the cost of higher risk.
These annuities are regulated by the Securities and Exchange Commission.
Indexed Annuities
Indexed annuities are hybrid investments that walk the middle ground between fixed and variable annuities.
Their performance is linked to a market index, such as the S&P 500 index, but they also offer principal protection. In exchange, their potential upside return is usually capped.
Immediate vs. Deferred Annuities
Immediate annuities, as the name suggests, start making interest payments as soon as you invest in them. Deferred annuities start their payout schedule at a pre-determined date in the future.
Choosing one over the other depends on your income needs, ability to make payments and other factors.
Step 3: Evaluate Your Budget
Even more so than with other investments, you should never invest more than you can afford in an annuity. This is because it can be very expensive to get your money out.
If you have a lump sum that’s already set aside for investments, dumping it all into an annuity at once can be an option. But many investors prefer to make periodic contributions, setting aside a smaller amount each month.
Whichever option you decide, be sure to account for your future financial and liquidity needs. You don’t want all of your money tied up in an annuity and unavailable for other purposes.
Step 4: Research Annuity Providers
Once you’ve narrowed down the type of annuity you’d like to buy, you’ll want to compare annuity providers to find one that fits your needs.
While most annuities are sold through insurance companies, you may prefer to buy one through a trusted financial broker, such as Fidelity. There are also online marketplaces that allow you to compare annuities between multiple providers to help you find the best one.
Financial Strength of the Insurer
Since annuities may provide income for decades, it’s a good idea to choose a financial institution with an excellent credit rating. This will help ensure that even years or decades down the road, you can still rely on the continuity of payments from your annuity.
Check credit ratings with third-party industry sources, such as A.M. Best or Moody’s. The higher an insurance company’s rating, the stronger its financial position.
Reputation and Customer Service
Annuity contracts and products can be complicated. As such, it’s a good idea to read reviews and testimonials of how prior customers have been treated at various insurance companies.
You’ll want to stick with firms that are well-known and well-reviewed, especially when it comes to their transparency regarding fees and annuity terms.
Step 5: Compare Annuity Products
There are so many different types of annuity products available that you’ll want to do your research before you make your decision about which to buy. Consulting an expert is a good plan, but you can also use online tools to compare various products side-by-side.
Consider the following when comparing products:
- Interest rates
- Fees
- Payout options
- Customizable rider options
- Death benefits
- Inflation protection
Be sure you are comparing similar products side by side. Take time to fully understand the features and benefits of each annuity, as they can sometimes be hard to discern at first glance.
Step 6: Consult With a Financial Advisor
As annuities can be complicated investments, it may be wise to meet with a licensed financial professional — such as a certified financial planner. These professionals can review your retirement plan and clarify how buying an annuity fits into that plan.
Some of the questions you might ask your advisor include the following:
- What type of annuity suits my goals, be they guaranteed income, tax-deferred growth or both?
- What are the fees and potential returns?
- Are there any surrender charges?
- Does this annuity match my risk tolerance?
- Does this annuity fit into my retirement timeline?
A fiduciary financial advisor, who is legally obligated to work in your best interest, is usually the best choice when making such an important financial decision. Some annuity providers may steer you toward products that may not be the best fit but generate higher commissions. A trusted advisor can help you avoid that situation.
Step 7: Read and Understand the Contract
Annuities can be much more complicated than other types of investments. If you buy a single stock, for example, you don’t have to review a multi-page contract to do it. But an annuity contract is filled with important legal requirements and restrictions that you must understand before you commit your money.
Key elements to review in the contract include:
- The surrender period and penalties for early withdrawal.
- Fees, including administrative, mortality and expense charges.
- Payout options and guarantees.
It pays to take a close look at the contract to see if there are any red flags that could trip you up.
For example, if the contract is vague or unclear, or if the wording seems purposely overcomplicated, there could be a catch to the good deal you think you are getting. The same is true if an annuity is paying a rate well above market, or if the literature makes promises or guarantees that seem too good to be true.
Step 8: Purchase the Annuity
You can pay for an annuity in one of two ways, either with a lump sum or with periodic contributions.
You’ll need to fund your annuity from your bank account or investment account — either by transferring funds over ACH or wire. You may be able to write a check to fund your annuity, depending on your provider. You may also be able to rollover funds from a 401(k) or IRA to fund your annuity, or even roll over another annuity using a 1035 exchange.
Some annuities are also available through an employer-sponsored plan. With this plan, your premiums come directly out of your paycheck.
Once you’ve made your choice, confirm your purchase with the issuer and receive the annuity contract, which is a permanent record of all the legal parameters of your investment.
If you buy an annuity and have second thoughts, most states offer a “free look” period on annuities. This period will vary by state, but is usually 10 to 30 days in length and allows you to cancel or change the policy without paying fees.
Benefits of Buying an Annuity
Annuities obviously have benefits, or they wouldn’t be so popular. Here are some of the most important.
- Guaranteed income during retirement: This is probably the No. 1 reason why most investors purchase an annuity. In most cases, you can turn the value of your annuity into a lifelong income stream, regardless of how long you live.
- Tax-deferred growth on contributions: When you put money into an annuity, it grows tax-deferred until you withdraw it, reducing your ongoing tax liability.
- Customizable features for long-term planning: The annuity business is highly competitive. Issuers have built significant customization features into their products so that investors can tailor their annuities to meet their specific financial needs.
FAQ
Here are the answers to some of the most frequently asked questions about buying an annuity.- What is the best age to buy an annuity?
- It's generally better to buy an annuity after age 59 ½, so that you can withdraw your funds without paying an early distribution penalty.
- How much does an annuity cost?
- There is no set cost for an annuity. Variable annuities are more expensive than fixed annuities, with charges that can run a few percentage points or more.
- Can I buy an annuity with an IRA or 401(k)?
- Yes, you can buy an annuity in an IRA or 401(k). However, as both of those retirement plans already offer tax-deferral, you may want to consult with a financial advisor to see if it's a wise choice to purchase an annuity in one.
- Are annuities a good investment for retirees?
- Annuities can be a good investment for retirees who are concerned about the safety of their principal and outliving their income.
- What happens if I need to withdraw money early from my annuity?
- You'll generally pay a steep surrender charge if you need to get money out of your annuity early. This can be as high as 8% or more in the early days of your annuity, with charges generally declining by one percentage point per year.
- If you're under age 59 ½ , you'll also face an early withdrawal penalty of 10% from the IRS.
Jacob Wade contributed to the reporting for this article.
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- U.S. Securities and Exchange Commission. "Annuities."