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What is an Annuity (Retirement Planning 101)

What is an annuity and do you need one for Retirement?

Annuities are a funny thing.

Some people swear by them and others see them as a total rip off.

I’m somewhere in the middle.

The truth is, an annuity is a financial tool that serves a specific purpose.

It can be a good thing… IF it’s used right.

The problem is that often annuities aren’t used right and people are often taken advantage of when they  buy them.

What is an Annuity?

I’m going to tell you a personal story to illustrate what I mean… but before I do, I want to remind you that the views and opinions in this post are simply my opinions.

These are the opinions of a random blogger who may or may not be a total idiot as far as you are concerned.

You should never make any financial decisions without first doing your due diligence and checking with your financial advisor because as I mentioned… I could be stupid and have no idea what I’m talking about… you don’t know… you just clicked on my blog post.

Okay, now that I got that out of the way, let me tell you a personal story.

Years ago I thought I was going to sell life insurance and I did for a time (or at least I tried to.. I didn’t sell much because I wasn’t good at it).

For me to work for the insurance company I had to get licensed.

For that to happen, I was required to take a test that covered all the products I would be licensed to sell.

Studying for that test was the first time I ever heard of an annuity.

I eventually passed my test and got licensed.

The company I worked for didn’t promote annuities, just life insurance.

So I floundered around trying to sell life insurance for a year with very little success… honestly, I failed miserably.

Even though we didn’t actively promote them, there were a few annuities we could sell if we wanted to.

So at least I learned what an annuity was.

An annuity is a product sold by insurance companies.

Buying an Annuity

Fast forward a few years later.

My wife came home from work after meeting with a “retirement specialist” who talked her into moving her retirement account to an annuity.

We were young and at that time it was not a good product for us to buy.

I knew immediately we got hoodwinked.

Well, we eventually got out of the annuity, although we were penalized for cashing it out.

What irritated me the most though, was that this “retirement specialist” was really an insurance sales rep going around promoting their annuity as an investment instead of what it really was…which is a financial product she got a commission for.

As a sales rep, she didn’t care about my wife.

She just wanted to make the sale, get her commission, and get out.

I know this because she wouldn’t return any of my calls when we tried to cancel it.

We had to contact the company and it was a long process to get somebody on the phone.

So to keep you from making the same mistake we made, let me give you a quick overview of annuities.

Annuities: Basic Overview

First, when you buy and annuity, you are just buying a guaranteed monthly income.

It’s basically a contract between you and the insurance company.

And yes, only insurance companies issue annuities so all the talk of growing your investment, portfolios, etc. usually points to one of the more complicated types of annuities, which usually means a higher commission for the salesperson… but we’ll get to that a little later.

The point of an annuity in it’s simplest form is to help you create a fixed income that will last you until the day you die.

That way you never run out of money in retirement.

Sounds like a great thing, right?

But the question then becomes, is an annuity a good idea?

Is an Annuity Right for You?

Well, that depends on how much you have to invest and what you’re looking to do.

My opinion is no, an annuity is usually not a good idea because there are other investments that will do better.

It’s the guaranteed income that sucks people in.

If you want a totally hands free, passive income stream (and are willing to NOT get the best returns), then yes, an annuity might be a good option.

It IS a financial tool and it CAN  be a good option if guaranteed income is all you really want and you’re willing to get a lower return on your money.

How Much do Annuities Make on Average?

For example, let’s suppose you have $200,000 cash to buy an annuity with.

Every company has their own products.

They would vary from company to company, but on average, a $200,000 investment would get you between $876 and $1042 per month for the rest of your life, depending on what age you bought it at. (https://www.annuityexpertadvice.com/how-much-does-an-200000-annuity-pay/).

The question you’ve got to ask yourself is.. how can an insurance company guarantee you an income for the rest of your life?

The answer to that question is because they’re going to take your money, invest it, and make way more money with it then they’ll be giving you.

They’ll just throw you some crumbs.

Let me illustrate my point.

Is an Annuity a Good Investment?

In the area where I live, there are neighborhoods where I could purchase a 3 bedroom, 2 bath home for $200,000 cash and rent it out for $1,500-$2,500 per month… for the rest of my life.

If I did that, I would have more cash flow than an annuity would provide for the same investment.

I also would still have the investment.

My rent payments wouldn’t be fixed like an annuity payment.

As inflation and the market drove rent prices up, my income would go up.

Also, as the home went up in value, I would benefit from owning that asset.

I could sell it down the road if I ever wanted a large sum of cash or I could put it inside of a trust for my kids…

There are a lot of options.

Of course, I would have to factor in the headache of managing it or the cost of a management company as well as repairs and vacancy rates.

But at the end of the day, I would still do far better in the long run by investing in a rental than I would by putting my money in an annuity.

Again, it depends on whether you want to maximize your returns or have a guaranteed, stress-free income.

Annuities can be a good financial tool as long as you understand what they really are and you understand ahead of time the decision you’re making.

Suppose you know all of that and you still think an annuity is the right move for you.

In that case, you’ll want to have a little working knowledge of the types of annuities on the market.

Types of Annuities

There are two different types of annuities, immediate and deferred.

They are pretty much exactly how they sound.

Immediate Annuities

If you buy an immediate annuity, the payments start immediately.

Deferred Annuity

If you buy a deferred annuity, the money you put in will grow and you defer taking payments until a later date.

Within these two types of annuities, there are also fixed annuities, variable annuities, and indexed annuities.

Fixed are the least risky and most predictable… but of course the returns are lower.

Variable Annuities (VA’s) are more risky but potentially could be more rewarding because they’re tied to an investment portfolio.

Fixed Indexed annuities (FIA’s) are kind of like a blend of the two.

In order balance the risk and reward, they are tied to an index.

They also usually have higher fees & costs.

Variable annuities (VA’s) and fixed index annuities (FIA’s) are complex and less straight forward than fixed annuities.

For this reason, they tend to pay greater commission to the salesperson… um.. uh… I mean to the financial advisor.

And because of that, 75% of the 200 billion dollars in annuity sales every year are VA’s and FIA’s. (https://www.thebalance.com/what-levels-of-commission-do-agents-earn-on-annuities)

I guess what I’m trying to say is, if you’re buying an annuity, make sure you understand exactly what you’re buying and that you trust the person you’re buying it from.

There’s a good chance they are getting a hefty commission for selling it to you and the more you’re spending…. the more they’re making in commission (generally speaking).

It’s important they have your best interest at heart.

If you get the feeling they don’t, look for another salesperson… dang it! I did it again….
Look for another “financial advisor”.

If you’re not sure where to start, I’ll put a few links below to help you out.

If you’re seriously thinking about an annuity as an income stream in retirement, you may want to first check out my playlist on land investing or my video on opening a ROTH IRA.

Please check out one of the other popular articles below to learn more ways to increase your income, build wealth, and live a life of abundance.

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God Bless,

Jason and Daniele
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