Why You Should Buy an Annuity
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WHY CHOOSE AN ANNUITY? Because they are personal pensions.
Annuities are an incredibly useful retirement tool when used correctly.
Annuities are a beneficial tool for one reason: GUARANTEED RETIREMENT INCOME FOR LIFE.
Now please understand--I don't recommend retiring solely with just an annuity. However, the right annuity will be a great addition to a total retirement plan.
Every retirement plan should have at least three components: Market exposure via equities, proper social security planning, and fixed income.
In the past fixed income was often times represented by a bond portfolio. Today we have a market where interest rates are so low nobody can turn to government bonds. Some corporate bonds have decent rates but the risk on those bonds has increased dramatically since covid.
The fixed income replacement for bonds? Annuities.
Annuities are a safe and guaranteed fixed payment for life during retirement. This is an income stream that isn't held to the mercy of market fluctuations. Nothing is guaranteed, not even social security, but annuities and social security are as close as we can get as guaranteed retirement income.
Stability is paramount in retirement. The guaranteed cash flow of social security combined with an annuity is an incredible combination for all retirees. If a retiree can have a paid for house then social security income and an annuity often times is more than enough to live a comfortable retirement.
HOW DO ANNUITIES WORK?
Annuities are contracts between an investor and an insurance company.
Someone uses funds they already have and allocate those funds into an annuity. When they are "annuitizing" the funds.--Someone is simply purchasing an annuity. There is no cost to the investor. They are simply allocating funds into the annuity.
So yes-- Entering an annuity is cost free for an investor. These annuities are investment contacts that are held with insurance companies. Also, the insurance company pays the financial advisor facilitating the annuity from insurance company profits. Furthermore the insurance company often times gives bonuses to people for simply entering into an annuity. It is not uncommon to see a $15,000 bonus given to someone for entering into the contract.
THERE ARE TWO PHASES OF AN ANNUITY
There is the accumulation phase and the annuitization phase
Accumulation phase: This is the beginning phase of an annuity. An investor can place a lump sum of money or make periodic allocations into the annuity. During this time the money is "locked up". The accumulation phase varies from contract to contract. However, during this phase an investor may access 10% of their principal amount penalty free. But to be clear the main goal of an annuity is to set the money aside for a set number of years until they are ready to "turn on" the annuity.
Annuitization phase: This is the the phase when an investor can "turn on" the annuity. This is the moment the investor has been waiting for. The money has been growing in the annuity and it is finally time to reap the benefit.
Example: An investor places $200,000 in an annuity. They also receive a $15,000 bonus. The annuity grows annually at 6% a year. In 10 years they will have $385,000. Then the annuitant decides to turn on the annuity and receives a 5% distribution. The investor will receive around $20,000 per year of stable income. This income will also continue to grow throughout retirement.
Combine this $20,000 with proper social security planning and down markets won't have an affect on your retirement. An investor can let their stock portfolio ride out market downturns without having to pull from the down portfolio. This
type of strategy provides a phantom return when you don't have to pull from your losses.
WHAT IF THE MARKET IS GETTING CLOBBERED?
Yes, you still will receive the guaranteed payments. In every contract there is a set minimum interest rate that the annuitant will receive. However, in good times, the annuitants account will still grow and they can participate in some upside of the market as well.
Annuities are the perfect offense/defense tool in a retirement plan. When the market goes up the annuitant can participant in some of the gains. When the market is down the annuitant can still receive the agreed upon minimum interest rate. Thus allowing the retiree to not have to pull funds from a stock market portfolio that is in a down market.
When should you Choose an Annuity?
I recommend entering into an annuity 10-15 years before retirement. Your goal is to "pensionize" some of your money. Most people don't realize that an annuity is simply just that. A personal pension that is set up for a retiree 10-15 years in advance.
Imagine the perfect retirement plan...
No debt, full age social security, a pensioned annuity, and equities growing in bull markets and not being touched in bear markets.
John Lawrence is a Financial Advisor and owner/founder of J.A. Lawrence Wealth Management.
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