Annuities are the amounts of money paid out to a person who has retired from work. They are paid in lump sum, monthly, quarterly or even annually depending on the retirement strategy. This usually happens if when you were still working you made some insurance contributions with retirement in mind.
One may choose to receive annuities for a given number of years or for the rest of your life. How much you get as annuity is largely influenced by the period of time you worked and other factors. However, you may influence the amount you receive by either taking up fixed annuity or a variable annuity.
There are essentially two types of annuities; deferred and immediate. Deferred annuity entails investing money for a time period until you reach your retirement while immediate annuity allows you to receive payments as soon as you make your first investment. This means that, as you start approaching retirement age, that is when you may consider purchasing immediate annuities. Immediate annuities are seen as a way of converting a portion of the retirement savings into perpetual earnings that lasts as long as you do. Immediate annuities may either be fixed or variable.
Fixed annuity basically means that you get fixed amounts of money for the given period of time, whether specified or for the rest of your life. The insurance company therefore calculates the fixed portions by taking into consideration the approximated time period left of your life and the amount of money paid into life insurance and pays this at regular intervals.
Most retirees prefer this method of investment as they are guaranteed and thus offer security; it is also easy to predict when you are going to receive the payments. Fixed annuities are also stable, in that the amount of money to be paid will not decrease no matter the economic levels. The insurance company takes on the risk of the annuities on behalf of the client. Fixed taxes also tend to offer the benefit of reduced income taxation on the annuities.
Unlike their counterpart, variable annuities are not as simple. In this case, the retiree does not receive steady cash payments; instead, they invest the money in securities portfolio whose performance then determines the amount of money they will receive as annuity.
The reason behind choosing variable over fixed annuities is the perceived high cost of living and incase of good performance of portfolio, more money will be received as annuity.
Most people however do not prefer nor recommend this type of investment given the uncertainty involved. It is particularly risky for a person without any other source of income. It’s unpredictability and irregular nature of the pensions should raise an alarm if nothing else. As if its not enough, variable annuities are subjected to income taxation at ordinary interest rates that may be as high as 35 percent which is a major disadvantage.
Immediate annuities are better preferred compared to deferred annuities. However, before you decide on whether to take up fixed or variable investments, put in mind your financial status and the amount of risk you are willing to make, to avoid grave financial mistakes.