An annuity can be an excellent instrument to add to your retirement portfolio. You have several different options in the types of annuities that offer different rates of return, purchase prices and fees. Let’s explore some of the factors that you need to consider when purchasing an annuity for income.
Types of Annuities
The two main types of annuities are fixed-rate annuities and variable-rate annuities. There are also immediate and deferred annuities.
A fixed annuity guarantees a set amount for the term of the agreement, and fixed annuity companies are less common than variable annuities. Variable annuities have a fluctuating rate that depends on the mutual funds that are included in them. An immediate annuity begins as soon as you make a lump-sum payment to the insurer. The most common type of annuity for retirement is a deferred annuity where payments begin sometime in the future.
One of the main differences between fixed annuity companies and variable annuity companies is the type of investments that they use. Fixed annuity companies often use stable investment instruments like U.S. Treasury securities and high-quality corporate bonds. A variable-rate annuity company often invests in a number of mutual funds.
Annuity Purchase Rate
The annuity purchase rate for a fixed annuity is usually lower than for a variable rate annuity. On average, you can expect an annuity purchase rate of between two to three percent on a fixed annuity. Some annuities will give you a set rate for a certain number of years and then switch to a variable rate annuity; these are called multi-year guaranteed annuities. The guaranteed period is usually between three to 10 years.
The annuity purchase rate will affect the annuity purchase price. Longer-term annuities will often pay out better rates than those with a shorter maturity. When calculating your annuity purchase price, you must also calculate any fees or expenses.
The annuity purchase price might fluctuate over time. The price and rate that you are offered depend on the products that are offered by the company.
Waiting for Better Rates
One thing that many people consider is waiting for annuity rates to rise when they are at a low point. This can be a mistake. If you buy a variable annuity when the rates are low, you miss out on the growth potential. You are also missing out on the compound growth that would allow you to have more invested when the rates rise. Purchasing an annuity sooner rather than later makes smart money sense, even when rates are low, and the annuity purchase price will be lower.
Rates are set by insurance companies using several factors as references. They use the 10-year Treasury bond and federal interest rates as key factors in setting annuity contract rates. When you are purchasing an annuity, it is an investment instrument that will have fluctuating rates over its lifetime. Also, what is considered a “good” rate must also take into consideration fees and for how long the rate can be expected to last.
If you invested $100,000 in an annuity that paid 2.4 percent, by year five you would have $112,589. If you waited for one year to invest, you would need to find an annuity that pays three percent to reach that same financial goal.
One way to get around lower value annuities during times of economic downturn is to ladder them. This means purchasing annuities with different maturity dates. You can spread the interest rates and reinvestment risk out over time, similar to dollar-cost averaging stocks. This can help ease the peaks and valleys of fluctuating interest rates over time and even out the income when you begin drawing income from them.
Adam Luehrs is a writer during the day and a voracious reader at night. He focuses mostly on finance writing and has a passion for real estate, credit card deals, and investing.