Is an annuity worth buying?

An annuity is a contract between you and your insurance company. Typically, you'll need a large sum of money in exchange for an insurance company's guarantee that a one-time payment will be made at a specified time, or a monthly payment (which is more common). Annuities can be paid instantly or at a specified future time to make your retirement more secure. Therefore, an annuity is a retirement planning tool that is worth considering.

However, there are many things you need to know before you buy an annuity, including the difference between a fixed annuity, an extended annuity, an index annuity and a variable annuity. Below, we'll give you a brief overview of what you need to know.

The Origin of Annuities

Annuities existed in the Roman Empire, even in ancient Egypt, and its recent history dates back to 17th-century Europe, when several thinkers came up with a similar agreement: a group of people who contributed a sum of money to build a common sum of money, and then they were regularly allocated a portion of the money. As group members pass, the number of people who split money decreases, and those who live longer can continue to be allocated funds.  In the United States, annuities began commercialization in 1812. Over the years, they have grown into a large-scale industry, with total sales of quota and variable annuities reaching $192 billion in 2017.

Why buy an annuity?

While investing and retirement accounts can pay off handsomely, your wealth will depreciate once the economy slows or enters a recession, a risk that keeps you up all night. On the other hand, as long as the insurance company is solvent one day, annuity income is guaranteed, and for this reason, you should only buy an annuity from a reputable insurance company.

An annuity can help you avoid running out of savings when you are a hundred years old. In addition, if you are worried that inflation will eat into the purchasing power of your wealth, an annuity can actually mitigate this risk. You can increase your contribution salittle or reduce the income you receive so that the amount you receive adjusts over time to catch up with inflation. The last thing to consider is that the older you get, the less interested and capable you tend to be in managing your investments. With or without notice, our cognitive abilities decline over time. Annuities reduce our responsibility for investment decisions and allow retirees to earn monthly income.

Types of Annuities

Before you buy an annuity, make sure you understand the different types of annuities on the market

Spot annuities or extended annuities - the former is paid immediately, the latter starts when you are older

Fixed annuity or variable annuity - the former distributes a fixed amount, while the latter distributes the amount to the performance of the whole or part of the market

Lifetime annuities or periodic annuities - the former are paid until the deceased of the beneficiary, while the latter is paid for a specified period of time

Now, let's take a closer look at the main types you might consider.

Fixed Annuities

Fixed annuities provide a fixed income, the amount of which is pre-specified and, to a certain extent, calculated at the current interest rate. Fixed annuities are the simplest type of annuity and many people are suitable to buy.

The following table is based on the quotes for the beginning of 2019, giving you a rough idea of how much you can earn from your fixed annuity. However, different insurance companies offer different offers, and the income level will fluctuate with the interest rate, the higher the interest rate, the greater the amount of the payment.  If a joint annuity is insured, the couple will continue to receive full income when one of the spouses dies. However, if each person is insured for an annuity, the late party's annuity will cease to be paid, and the party will only receive its own annuity income.

Deferred Annuity 

A fixed annuity can be paid immediately, but there is another annuity worth considering that can start after a specified time (e.g. 10 years), which is an extended annuity. If you're long, extending your annuity can prevent you from spending your money too early. Such annuities are suitable for purchase in middle age and while they are still in work, so that they can earn income throughout retirement.

In the case of a 65-year-old man insured at $100,000, he could be paid $1,329 a month from the age of 75 after 10 years, or $2,115 a month from the age of 80 after 15 years (for example, as of early 2019). Deferred annuities are larger because insurance companies can save your premiums for a period of time and invest them before they start distributing income to you. In addition, insurance companies may pay fewer times because you start collecting your money.

Variable annuities

Fixed annuities provide the amount spent under the contract, and the income provided by variable annuities and index annuities is linked to the performance of the stock market or investment of your choice, so the income they provide changes. Variable annuities usually have a cumulative period, the former is the period of premium accumulation and interest, the latter is the period of income paid to you by the insurance company. Your premiums are usually invested in mutual funds and are expected to grow over time.

Advantages of variable annuities

Here are some of the catchy features of variable annuities:

Provide multi-year income. You can choose to keep your income until you die to help you avoid the difficulty of spending your savings in retirement. (Fixed annuities also have this advantage).

Compensation for death. Some variable annuities allow you to select a beneficiary who will receive a certain amount if you dye before receiving all the guaranteed amounts, or if your account balance exceeds a certain level. However, you will be charged an additional fee for this.

It's up to you. Variable annuities give you more control than a fixed annuity, and you can choose how to invest money in your account, whether it's conservative, aggressive, or both. However, this is not an advantage for everyone, especially if you are not a savvy investor. If you choose the right choice, your earnings will increase, but there is no guarantee, and you are at risk of underperformance of your investment, giving you less than you expected or expected.

Weaknesses of variable annuities

Fees are the biggest drawback of variable annuities. Variable annuities may charge you death and operating risk charges (mortality expenses and risk charge, typically about 1.25% per annally per year) and general administrative costs (about 0.25% per year). In addition, the securities invested in annuities (e.g. mutual funds) will be charged their own fees at a rate of 1.35 per cent. These fees usually do not change significantly year by year, and the fees of mutual funds have been falling over the past few decades.

Together, these fees make many alternatives look more attractive than variable annuities. For example, a above-average rate can total 2.85 per cent (excluding additional costs such as death compensation). Suppose you buy a $100,000 variable annuity and you pay $2,850 a year. If your variable annuity increases by 6% per year, remember that 2.85% of this is not yours, i.e. your return will shrink to 3.15%. If the annual return is 6 per cent, an investment of $100,000 will increase to $179,085 over 10 years, but if the annual return is 3.15 per cent, it will only reach $136,362, which is $42,723 less!

Index Annuities

Index annuities are sometimes referred to as "fixed index annuities" or "stock index annuities" and are linked to the performance of indices such as the S.P. 500.

You can invest lightly in the S.P. 500 (which can charge as little as 0.10 per cent or less) through low-rate index mutual funds such as the Pilot 500 (VFINX) or exchange-traded funds such as the SPDR S.P. 500 ETF (SPY). But if you invest in a fund that tracks the S.P. 500, and the S.P. 500 falls or even plunges, so does your investment (although in the long run, the index will always rebound and hit new highs). This volatility scares some people, so index annuities are good news for them, and they usually promise not to erode money or guarantee a minimum return.

But these commitments come at a cost. If you look at the sub-rules of an index annuity (be sure to do so before you invest in an annuity), you'll see that while your downside space is limited, your upside space is limited and your earnings are limited in many ways.

The first is the "participation rate", which measures the proportion of the relevant index return you can get in terms of return on investment. Assuming the Standard and Poor's 500 index is the benchmark, it's up 10% for the year, and your participation rate is 100%, and your index will be 10% (100%) of 10%. If the participation rate is 80%, the index remuneration is 8% (80% of 10%).

With little or no loss guarantee, such annuities seem like a pretty good choice. However, don't be happy too early, such annuities have a cap, you can earn a lot of money is limited. Assuming a 7 per cent cap, even if the S. and P. 500 surges 20 or 30 per cent for the year, your yield will not exceed 7 per cent. Even worse, returns are usually deducted from some annual fees, which can have a big impact on earnings.

To show how limited the performance of an index annuity is, Fidelity analyzed some of the data. For example, they point out that in 2013, the S. and P. 500 surged by about 30 per cent (including dividends, compared with 32 per cent for dividends), while an annuity represented a return of only 10 per cent. They also reviewed data for the decade to 2013 and found that the S.P. 500 is up about 7.4 per cent a year, while annuity returns are up 3.2 per cent on average. (The return on an annuity has been 0% for many years. The gap between the two is huge. If a $10,000 investment grows at 7.4 per cent, it will become $20,400 in 10 years, but if it grows by 3.2 per cent, it will only become $13,700.

Programmes other than annuities

In addition to annuities, there are other ways to help you build a source of income. For example, you can build a dividend-paying bond or stock portfolio that is similar to an annuity income. Many robust stocks have dividend yields of 3%, 4%, 5% or more, and even a simple index fund that tracks the market will pay dividends.

Suppose you have a $300,000 equity portfolio with an average dividend yield of 4%, which will bring you $12,000 a year, or $1,000 a month. Better to do, a robust and growing company will generally increase its distribution, so your income is somewhat inflation-resistant (of course, there is no absolute guarantee of a distribution amount, for this reason you should use a robust and growing company and spread the money to at least a few companies)