Annuities are secure life insurance policies that provide a steady stream of income over time, following a lump-sum or long-term investment. The intention of this reliable income source is usually to supplement retirement.
There are different types of annuities, classified by payment frequency. In seeking an annuity, understanding what features should be avoided and what makes a bad one is essential.
Let’s take a look at these important financial investments, along with which types can be the worst and why they should be avoided.
An annuity is a contract issued by a financial institution that involves making payments to accumulate funds in order to receive a fixed stream of money in the future. Those who need a guaranteed, stable income for retirement can turn to financial institutions to purchase these contracts. Life insurance, Social Security, and benefit pensions are all examples of annuities.
Annuitants, or those to whom these policies are distributed, make monthly or lump-sum payments. Then, at a specified date, annuitants receive regular payments from the holding institution for a designated length of time or the rest of their lives. They are primarily used as a resource to ensure you won’t outlive your savings in retirement.
Designed to deliver reliable income for retired individuals, annuities help people rest assured that their assets won’t run out during their lifetime. Good annuities and bad ones all have phases, the two most important being accumulation and annuitization.
Accumulation is the initial stage for annuity holders to build up their investments and make payments. In this stage, invested funds are tax-deferred as the annuity grows. Annuitization is reached when the annuitant starts receiving regular payments, either for a fixed period or the remainder of their life.
Types of Annuities
How annuities are structured varies in multiple ways. Some are immediate, and these can be considered among the worst types. Others are deferred and are likely preferable.
Immediate vs. Deferred
Immediate annuities are often purchased when someone receives a large sum of money, through winnings or a settlement, for instance, then opts to invest the funds to begin immediately receiving money in a steady stream of payments.
Deferred annuities accumulate over time and defer annuitization, with benefits beginning at a predetermined later date. The tax considerations surrounding all annuity types can be complex, so it’s wise to consult an experienced professional prior to entering into a contract.
Fixed vs. Variable
An annuity can be variable or fixed. A fixed annuity distributes fixed payments for a pre-set length of time, like 20 years, regardless of the annuitant’s longevity.
Payments from a variable annuity depend on the success of the investment, given the condition of the stock market upon retirement. A variable annuity requires betting on a notoriously volatile market and is one of the riskiest and worst annuities for reliable financial planning.
Added flexibility can be achieved through fixed-variable hybrids. Always consult with a financial advisor before committing to such a complex financial product as an annuity.
What’s a Bad Annuity?
Avoid being haunted by an unwise financial decision down the line. Watch out for these warning signs and features associated with the worst annuities.
Annuities are meant to be a safe investment for stable retirement planning. Since securing funds for the later stages of life is vital, this money shouldn’t be gambled. Potentially money-losing investments can make the worst annuities.
Variable annuities, for example, are especially risky, as the investment’s value is subject to the unpredictable stock market, making major losses possible. Other potentially bad annuities that can end up costing more than they’re worth are registered index-linked annuities and those with excessive or unnecessary fees.
Fixed annuities can guarantee investments are unaffected by stock market volatility, with consistent payment distribution regardless of interest rate fluctuations. Fixed deferred annuities are one of the better options to provide a reliable stream of income for retirement.
Some of the worst annuities require annuitization, involving an irreversible relinquishment of control over the payment distribution. These tend to have low interest rates and might not cover beneficiaries in the case of the annuitant’s death. Plus, if financial difficulty is experienced later in life, lacking access to the funds then could be regrettable.
Immediate, deferred income, and qualified longevity are some types of contracts that require annuitization, making them some of the least advisable investments. There are better options than settling for bad annuities.
Alternatively, annuitants who opt for deferred annuities with lifetime income riders can ensure more flexibility, allow for interest accrual, and provide for beneficiaries.
Poorly Rated or Captive Financial Institutions
It’s essential to contract with a reliable financial institution to avoid a bad annuity. There’s an abundance of options to choose from, so always research and review several before making a decision. Review financial ratings and avoid those at or below B++, as this isn’t a strong indicator of financial strength, stability, or longevity.
To avoid the worst annuities, it’s also wise not to contract with captive financial institutions that exclusively sell their own products. With such a vast market available, these institutions are usually not the best options. A quick search can provide a list of captive financial institutions. Reduce your odds of a bad annuity by avoiding them.
When a consumer purchases an annuity from a captive financial institution, there’s a greater likelihood they will get a raw deal. A better option is to work with a highly-rated independent financial professional who can offer access to a wider range of products. Having more to choose from can facilitate the ideal selection.
Annuities are a wise financial investment for many, and they come in various forms. Purchasing an unsuitable annuity can lead to financial losses. Select the right annuity for your own situation and needs with the assistance of a qualified professional versed in the various tax considerations and riders available for each.
Always perform adequate research on financial advisors and institutions, and be mindful of the red flags that indicate the worst annuities. By factoring all this information into your decision-making process, you can steer clear of bad annuities and successfully identify the right annuity from the right financial institution that is best suited for your unique needs.