As the cost of living and inflation continues to rise, even high-earning medical professionals have to get creative about retirement planning. Annuities can be a viable investment option for retirees needing more income to meet their financial needs.
The best annuity for you and where you buy it will depend on your financial situation, so it can be helpful to work with a financial planner or another trustworthy advisor to determine your retirement goals.
In this article, we’ll look at how to buy an annuity, the different types of annuities, and more so you can make an informed decision for your financial needs as a physician.
What Is an Annuity and How Does it Work?
Annuities are contracts that provide an income stream to supplement your savings accounts, especially during retirement.
They provide long-term income, but they aren’t straightforward investment strategies.
The main benefits of annuities include retirement income, portfolio diversification, and principal preservation.
Annuities are contracts issued by an insurance company. The type of annuity and the contract details determine your future annuity payments.
Why Do People Buy an Annuity?
The main purpose of annuities is to transfer your longevity risk, which is the risk of outliving your savings, to the insurance company.
Annuities payout for the rest of your life, regardless of how much you originally paid.
Transfering your longevity risk can reduce the stress of future financial burdens as you approach retirement.
How to Buy An Annuity: Step-by-Step
You can purchase the right annuity by taking your time throughout the purchasing process. We’ve prepared a few tips to help you choose an annuity contract that fits your needs.
1. Investigate your retirement plan
If you’ve been proactive, you’ve been saving for retirement for years. Take an honest inventory of the funds in your retirement plan and any other income streams you expect after you stop working.
2. Determine your financial needs
Work with your spouse, loved ones, or a financial advisor to set your financial goals. Consider the standard of living you currently have and what it will cost to maintain it through retirement.
3. Learn all you can about the types of annuities
Different annuities function in different ways. You’ll want to set your priorities at this stage. Is it more important to grow your original investment, or do you want a predictable lifetime income you can count on?
4. Inquire about fees
Fees can eat into your overall investment if you’re not careful. Ensure you know any maintenance fees and commissions for your annuity contract.
5. Research financial strength
The insurance company needs to be solvent enough to payout annuities when it comes time to collect. Consult Moody’s, Standard & Poor’s, A.M. Best to learn more about the financial strength of your desired annuity provider.
6. Apply and fund the annuity
You’ll need to go through a qualification process to ensure you’re a good fit for the insurance company, so make sure your application is filled out clearly and accurately to minimize processing delays. Once approved, you can fund the annuity with a transfer from your retirement account, cash, and even life insurance policies.
Can You Buy an Annuity Online?
Yes, you can buy an annuity online directly through the insurance company, bank, or brokerage firm, but you may want to consider working with an advisor or broker if you aren’t used to reading annuity contracts.
Elder Americans and retirees are vulnerable to scams, so you’ll want to be careful before signing anything or providing payment information.
State regulatory agencies oversee all annuities, but variable annuities are securities, so they’re overseen by the U.S. Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) for an extra layer of protection.
As such, you can look up these annuity companies and brokerage firms on FINRA’s BrokerCheck and the SEC’s Action LookUp to ensure they’re reputable.
Pros and Cons
Like all investment options, annuities have advantages and drawbacks.
The pros and cons can vary significantly depending on the type of annuity you purchase, but we’ve prepared a short list for you to consider.
- Guaranteed future income: Annuities provide guaranteed income that supplements Social Security and retirement savings for the rest of your life.
- Personalized features and rider options: Annuitants can customize their policy to their financial plan.
- Portfolio rebalancing services: Some annuity providers offer additional money management services, such as portfolio rebalancing and diversification.
- Tax-deferred growth on invested principal: If you have a tax-deferred annuity, you won’t have to pay taxes on your invested principal until you start receiving payouts.
- Fixed interest rate: Fixed annuities allow you to lock in an interest rate, giving you a better idea of your future income.
- No contribution limits: Unlike 401(k)s and individual retirement accounts (IRAs), annuities don’t have contribution limits, so you can put up as much money as possible for your annuity purchase.
- Protection against market volatility: Fixed annuities are protected from market downturns because the principal balance will never decrease, which can be great for individuals with low-risk tolerance.
- Death benefits: If you pass away, your beneficiaries can continue to collect a lump-sum annuity payout or a percentage of the expected income payments.
- High commissions and administrative fees: Policyholders may be charged maintenance and risk fees while they hold the annuity. They may also be liable for sales commissions if they unload the policy.
- Tax penalties for early withdrawals: You may be subject to a 10% penalty if you withdraw before retirement age.
- Large premium payments and rider costs: Annuities aren’t an affordable investment option. Many of the best features of annuities come at an additional cost that can water down your original investment amount.
- Surrender charges if you cancel: Annuities aren’t a flexible investment product. You may be responsible for significant surrender charges if you cancel outside your free-look period.
- Complex terms and conditions: Annuities aren’t written for the layman. The policy terms can be confusing and difficult to understand if you don’t have robust financial literacy.
- Difficult to liquidate: You can’t just cancel an annuity contract on a whim, so it can be difficult to get your money back if you need access to cash quickly.
- Pays out during your life: Unlike life insurance, you can reap the benefits of your income annuity while you’re still around to enjoy it.
Types of Annuities
- Immediate Annuities: Immediate annuities are funded with a lump-sum payment. As the name suggests, the payments begin immediately and are not deferred to a time in the future. Immediate payment doesn’t have the same benefit as some tax-deferred annuity options.
- Deferred Annuities: Deferred annuities can be funded with a lump sum or periodic payment. These annuities grow tax-deferred until the payout phase begins.
- Fixed Annuities: Fixed annuities guarantee a rate of return for a set period of time and may renew at a different rate after the initial period ends.
- Variable Annuities: Variable annuities earn interest through investments that you select. These annuities do not guarantee a rate of return.
- Indexed Annuities: The rate of return is tied to a market index, such as the Standard & Poor’s (S&P) 500, for indexed annuities. They offer a guaranteed minimum rate of return.
Annuities have a few key features it’s helpful to understand.
The free-look period is the time, as defined by your state, required to allow you to cancel the contract without paying a surrender charge.
Riders are addendums that add customization to annuity contracts.
While riders allow you to add additional benefits to your annuity contract, they typically come at an additional cost.
- Death-Benefit Rider or Guaranteed Minimum Death Benefit Rider: This rider allows you to add beneficiaries to your contract who will receive a portion of the contract value at your death.
- Disability Income Rider: This rider ensures higher income will be paid for a limited time if you become disabled.
- Impaired Risk Rider: If you have documented health risks that may lead to a shorter life, this rider can accelerate your annuity payments to account for a shorter payout time.
- Long-Term Care Rider: This rider increases your income if you require long-term care. It is typically based on a multiplier of your normal monthly annuity payment and is limited to a few years.
- Cost of Living: This rider increases your monthly annuity payment with inflation or a specified percentage dictated by the annuity contract.
- Return of Premium: This rider gives the unpaid portion of your premium to any beneficiaries upon your death. The unpaid portion equals your contributions minus the payments made to date.
- Fees and Commissions: When an annuity is sold, the financial professional typically makes a commission. On top of the commission, additional fees can be charged for added riders, management fees, and more. Ensure your annuity provider offers a clear breakdown of the applicable fees and commissions before you purchase the contract. If you need more than the contracted annuity payment, expect to pay withdrawal fees.
- Taxation for Annuities: If you purchased an annuity with after-tax money, then the portion of your annuity payments that came from earnings is taxable. Annuities are taxed similarly to taxable brokerage accounts. However, the taxation is deferred until you withdraw the funds with an annuity.
Frequently Asked Questions
How long do you have to live to get your money back from an annuity?
There isn’t a simple answer to how long you have to live to get your money back from an annuity. It depends on how your annuity is structured, how long you’ve been collecting, and whether or not you have a survivor benefit.
You can discuss your annuity options with a financial advisor to ensure you get a good value from your investment.
What is the cost of a $1,000-per-month annuity?
The cost of a $1,000-per-month annuity can depend on whether you make a single payment for an immediate annuity or if you pay into it over time. The cost for an immediate annuity that pays $1,000 per month may range from $178,306 to $185,000.
You can shop around for an annuity that meets your needs and budget.
What is the difference between an annuity and a pension?
The difference between an annuity and a pension is annuities are purchased by individuals from insurance companies, whereas pensions are provided by employers. Both can supplement retirement savings.
Do you have to fund an annuity in full when you purchase?
No, you don’t have to fund an annuity in full when you purchase if you have a multiple premium contract. Single premium contracts require payment upfront, but multiple premium contracts spread the cost over premium payments.
How long does it take to buy an annuity?
It can take anywhere from a few days up to several weeks to purchase an annuity. The speed of processing your application depends on how well you filled out the application, the responsiveness of the annuity provider, and any other imposed policy conditions, such as medical exams or additional documentation. It can also depend on how you fund the annuity.
Is an Annuity A Good Investment?
Annuities can be a good investment if you already have a diversified portfolio or you recently came into a lump sum of money. However, there may be better investments if you have complex needs or you die before collecting the full benefit.
A fiduciary financial advisor can help you analyze your financial situation and plan accordingly. Sometimes, they’ll have the right annuity for your needs, and other times, you may want to focus more on other investment vehicles, such as mutual funds or rental properties.
Because fiduciary advisors are legally obligated to put your needs above their bottom line, you can trust that they provide unbiased advice for your unique situation.
The right annuity will provide a reliable stream of income that can support you throughout retirement without detracting from your ability to meet other financial goals in the meantime.