Annuity: A Good Option for Pension/Retirement Income?
Fund-Matters | July 24, 2023 | Annuity, Income, Insurance, Personal Finance, Retirement, Retirement Planning, | 0 Comments
Annuities:
Insurance companies have been investing their clients’ retirement money in annuities over the years. This practice has its detractors, with the criticism mainly focusing on the high commissions paid to annuity sales personnel and the stiff fees charged to annuity owners year after year. In fact, when comparing the costs of an annuity Vs. mutual fund, there can be a huge difference, with a mutual fund being less expensive. So, it pays to know the details about annuities before you invest.
How Annuities Work:
An annuity is a contract between an individual and an insurance company. The investor contributes a sum of money — either all up-front or in payments spread over time — and the insurer promises pay them a regular stream of income in return. With an immediate annuity, that income begins almost right away. With a deferred annuity, it starts at some point of time in the future, typically during retirement. The amount of the annuity payments is determined by such factors as the contribution amount and the age of the investor.
Annuities can be structured to pay income for a set number of years — say 10 years or 20 years, or for the life of the annuity owner. When the owner dies, any money remaining in the account typically belongs to the insurance company. (Though there are some annuity plans, where the principal amount remaining in the account is returned to the dependent, after the death of the annuity owner. In such plans, the annuity pay-out may be relatively lesser.)
Annuities can also be fixed or variable. In a fixed annuity, the insurance company pays a specified rate of return on the investor’s money. In a variable annuity, the insurance company invests the money in a portfolio of mutual funds/stocks/bonds, chosen by the investor, and the return will fluctuate based on their performance.
Pros of Annuities:
- Guaranteed pension income:
The main feature of an annuity plan (fixed annuity plan) is the payment of pre-determined and guaranteed annuity amounts every month/ quarter/ year to the annuity owner till his or her death. The insurance company is responsible for paying the income it has promised, regardless of how long the annuity owner lives.
- Customizable features:
You can customize an annuity to fit your needs, but you’ll usually have to pay more or accept a lower monthly income. Annuity contracts can often be adapted to match the buyer’s needs. For example, a death benefit provision can ensure that the annuity owner’s heirs will receive at least something when the owner dies.
- Money-management assistance:
The insurance company invests the contribution amount of the annuity owner in a portfolio of mutual funds/stocks/bonds. Hence, the insurance company does the money-management for the annuity owner.
Cons of Annuities:
- High commissions/ High Fees:
Annuities often have high fees compared to mutual funds and other investments. This is due to the high commissions paid to annuity sales personnel and the in-built risk coverage premium. Annuity contracts impose annual maintenance and operational charges that often cost considerably more than the expenses on comparable mutual funds.
- Surrender charges:
If you wish to surrender your annuity plan, for any reason, prematurely — the insurance company will deduct a substantial amount as surrender charges and return only the balance amount to the annuity owner. In contrast, one can liquidate the mutual funds and any other investments without any such surrender charges (when they need the money).
Conclusion:
Even though annuities do provide guaranteed pension incomes, there are high fees and cumbersome procedures. One practical option for investors could be- to stick with mutual funds until retirement and then move some of their money into an annuity. That keeps the fees to a minimum during the investor’s working years but guarantees a steady income in retirement.
