Every person will need a source of income when they retire. An annuity can provide a retiree a dependable and reliable form of dollars for the rest of their life. There are some drawbacks with annuities. However, some of those drawbacks can be avoided if you make some smart choices.

Here are a few things you should take into consideration regarding the upside and downside of fixed annuities:

Annuity Safety

• Pros – The premium that your insurance company invests as part of your portfolio is never lost. The company is often backed up with substantial funds to protect your money.
• Cons – The cost of this type of safety means limited growth potential. For some people, this isn’t good enough.

Guaranteed Earnings

• Pros – The interest of your annuity is protected against loss. This is a great benefit when the market is volatile.
• Cons – Since crediting only takes place once a year, your earning potential is dependent solely on how the market works on one day. This means you could have significant gains. On the other hand, you could get wiped out.

Caps and Rate Spreads

• Pros – You have the option to track your performance. The cost of the option dictates how much of a gain received. The yields are greater than any safe asset.
• Cons – Expectations may not be great. But if you can find better options, do so.

Surrender periods

• Pros – Relative to safe money, CDs and Bonds have long commitments. Annuities have protection from interest rates.
• Cons – Experts often say you don’t need to lock money up for an extended periods. It all depends on what you are doing with the money. If the withdrawal annuity isn’t enough to meed your needs, it’s not for you.

The bottom line is annuities can generate a lifetime of income. Many annuities are increased to keep up with inflation. An example of an annuity is a 65-year-old man receiving a $100,000 annuity. The man would receive about $546 monthly income. This money is a permanent stream of income that will last a lifetime.

Another consideration about lifetime annuities is that you could actually die without having benefited significantly. If this happens, it means the annuity could go back to the annuity company.

People should also know that not all annuities are created equal. The range is quite expansive:

1. Immediate vs deferred – Some annuities can begin paying immediately, and others can be deferred to start at a later date.
2. Fixed vs variable – Fixed have fixed interest rates and predictable income. Variable have to do with the overall market.
3. Lifetime vs fixed period – Some lifetime annuities pay for the rest of your life. Others can pay for a standard number of years like 10, 15, or 20.
4. Single premium vs multi-premium – You can deposit one check or many over a period of time.
5. Single owned vs joint owned – You can buy a single annuity for one person. Or you can purchase an annuity for both partners.

There are several types of annuities that are available on the market. One of the main types of annuities is the variable annuity. Part of the variable annuity is a self-directed investment product, and the other part is an insurance product. The self-directed investment part of a variable annuity, known as the sub-account, allows you to decide how your contributions are invested. The amount of money you can earn in this sub-account depends on the performance of the investments you choose. You can choose from a pre-selected list of mutual funds, bond funds, and money market accounts. You can also choose to be an aggressive investor, a conservative investor, or an investor that uses a combination of the two strategies.

The insurance aspect of a variable annuity means that the principal balance of your annuity will be paid to your beneficiary no matter how poorly your sub-account performs. For example, if you put $50,000 into a variable annuity and you pass away at a time when your sub-account is losing money, your beneficiary will still get a $50,000 death benefit. Since a variable annuity is considered an insurance product, all the interest, dividends, and capital gains are tax-deferred. You are only taxed when you begin to receive payments from the annuity at retirement or when you withdraw money before you turn 59 ½ years of age.

Is a variable annuity right for you?

There are many benefits to owning a variable annuity, such as:

• Having flexible investment options
• Having tax-deferred investment growth
• Having a lifetime stream of income
• Allowing beneficiaries to avoid probate when they receive your assets

Unfortunately, a variable annuity is not for everyone. A variable annuity may not be right for you if:

• You are less than 10 years away from retirement or 59 ½ years of age
• You are wealthy and have other income-producing investments
• You have serious health issues

Do your due diligence

A variable annuity is a long-term investment that requires a thorough understanding of how it works. They have ongoing fees, and if you make an early withdrawal, there is a 10 percent tax penalty. Be sure to work with a trusted financial advisor and have them explain in detail how a variable annuity works and if it is the right option for you. Insurance companies typically offer a 10-day free look period option where you contribute to a variable annuity to see how it works. Take advantage of this free look period to study how the variable annuity works first hand to see if it’s compatible with your situation.

A popular long-term retirement product is an indexed annuity. It provides a combination of different features of variable and fixed annuities. This annuity is like a fixed annuity because it provides a guarantee of a minimum return. It resembles a variable annuity because its rate of return is based on stock market performance. It is possible to purchase an indexed annuity from an insurance company. The terms and conditions of the payout will be based on the annuity contract.

1. Stock Performance: Indexed annuities provide those who own them with the chance to earn higher returns based on stock market performance. It also provides protection against any type of market decline. Those who have an indexed annuity often receive returns that are lower than anticipated. This is because deductions are taken from returns that are fee-related. There is also a cap on the maximum amount of interest an indexed annuity can earn.
2. Minimizes Risk: Someone who wants to avoid risk may want to consider adding an indexed annuity to their portfolio. It is often very attractive to individuals who are working on their retirement or getting close to retirement age. One of the goals with buying an indexed annuity is to have a better return than other investment vehicles like bonds, CDs or money markets and still protect the investment principal. In a typical year, the purchases of indexed annuities could represent over 29 percent of all annuity sales.
3. Surrender Charge: The mechanics of indexed annuities are often very complicated. The returns an indexed annuity holder may receive could vary by a considerable amount based on the year and month they purchased it. There is often a surrender charge for any type of early withdrawal. Charge-free surrender periods could be as short as 3 years and as long as 16 years. The average surrender period is ten years.
4. Rate Cap: If the index increases by 15 percent, the holder of an indexed annuity won’t experience a 15 percent return. The indexed annuity interest rate will have a cap. It’s possible for a 15 percent increase to result in a 5 percent return. It’s also important to realize interest rates for indexed annuities are calculated using a participation rate. This means the interest rate is a predetermined percentage of the increase of an index. If an index increases by 10 percent and the annuity provides the holder with an 80 percent participation rate, the indexed annuity would provide an 8 percent return. This will happen as long as it is not more than the rate cap.
5. Taxation: Any type of gains experienced from an indexed annuity is taxed the same way as a fixed annuity. Taxes are deferred until the holder of the annuity receives the money. Interest in a fixed annuity is taxed first and at the same rate as regular income.

Indexed annuities are regulated by a state’s insurance department. When an investor purchases an indexed annuity, they must choose a deferred option or an immediate option. With an immediate option, an investor will begin receiving payments right after purchase. A deferred annuity provides an investor with the opportunity to let their annuity grow for a predetermined length of time.