Countries around the world are still reeling from the recent global economic downturn. Rising inflation and costs of living, loss of jobs and reduced income seems to be the general landscape of our times, for communities all over the world. In this light, many of us are exploring the best way to maximize our assets to provide financial security during retirement. Buying an annuity is often considered a good move in terms of financial planning during retirement. Let us look at how annuities work and consider the option of buying an annuity in the current global economic climate.
What is an Annuity?
An annuity is a form of investment, usually sold by insurance companies. In exchange for a premium, the annuity company provides a monthly payment to the annuity holder. The amount paid depends on the rate of interest, as well as the type of annuity.
Annuities are characterized by the way the interest is payable, as well as when payments are made. The two main types of annuity are immediate annuities and deferred annuities. Immediate annuities start to make payments immediately after buying an annuity, while deferred annuities are made in the future – a period after the initial investment is made.
Within these two types, there are fixed interest rate and variable interest rate annuities. This depends on what type of investment the annuity is linked to. The main benefit of annuities is that they allow you to save a chunk of cash on a deferred tax basis.
Needless to say, the way the annuity works has a bearing on the amount of risk involved in buying an annuity as an investment.
Concerns with Annuities in the Current Economic Climate
The current economic downturn means that interest rates are nowhere near the unrealistically soaring rates available to investors some years back. Generally, very low interest rates are an important factor that investors are considering while weighing the pros and cons of buying an annuity.
Another factor that may add to the risk involved with buying an annuity is the volatility of the market. An annuity that is linked to the market is exposed to the rewards as well as risks of the ups and downs of the market, and this uncertainty worries many investors.
The two main concerns most investors approaching retirement age and considering buying an annuity are that volatility means they may end up losing their life savings, and very low interest rates mean that they may not receive enough value from the annuity. Outliving your savings is another important concern.
Using Annuities to Your Advantage
Waiting for interest rates to improve is a strategy that some who are concerned about current low rates opt to do. However, this means even if interest rates should improve in the future, you may be left with a smaller amount to invest in the annuity, having used some of your savings. Buying an annuity that starts making payouts immediately has some benefits for those who require income assistance immediately and could be looked at as part solution for income planning during retirement. Also, by investing a lump sum into an annuity and receiving regular income from it, you can streamline your savings and help create a monthly budget, which is good from the point of view of planning your expenses.
Fixed Annuities provide a fixed interest rate on your premium, which means irrespective of what happens in the wider market, you are entitled to a fixed rate of interest on your savings. The advantage of buying an annuity of this type is of course that you are protected from the volatility of the market, but the flip side is that the interest rates tend to be extremely low.
Variable annuities may be linked to wider investment options like stocks and bonds, and the pay-outs depend on the performance of the investments. For many people, buying an annuity which is a combination of fixed and variable types is often the best option. This can be a good way to have control over a portion of the annuitized savings, by having a say on where the money is invested. With the rest, you are assured a minimum guaranteed income.
Buying an annuity can be particularly useful for those approaching retirement age and wishing to make their savings work for them during retirement, while deferring tax payments on the amount. Although the current economic climate raises concerns for investors, annuities can be used flexibly to make them work for you, and still present one of the more reliable ways for income security during retirement.