Although annuities for young people may not be the most obvious savings and investment choice, they can nonetheless make a great deal of financial sense. When you’re young, it’s virtually impossible to think about retirement. With so many things to do and events to plan for, retirement probably won’t even make it onto the list of financial priorities for several years or even a couple of decades.
The trouble with this outlook is that life speeds by in the blink of an eye. Before you know it, retirement will be right around the corner, and it’s not the kind of thing you want to wait until the last-minute to plan for. That’s why an annuity can make so much sense for young people in certain situations.
What Are Annuities?
Annuities are an investment tool sold by insurance companies. The annuity begins when an investment is made. Then, payments are made back to the investor either in a single lump sum payment or as a steady stream of payments made annually, quarterly or monthly. When the account is set up, you essentially choose how long you will receive payments. This may be for the rest of your life or for a predetermined number of years. It’s important to understand that while such accounts can be a good investment, they also come with a relatively high level of fees and surcharges which will not make financial sense for everyone. Consulting with a financial advisor is always a good idea when you’re doing some retirement planning or thinking of making investments.
Immediate and Deferred Annuities
These are the two basic types of annuities. An immediate version of this financial product begins making payments to you almost as soon as you make your investment. These accounts typically make the most sense for people who are nearing retirement. The deferred version accumulates money that is paid out later. This often works for people who have many years left to work.
Fixed and Variable Annuities
Within the immediate and deferred categories are two further subdivisions: fixed and variable. The fixed version pays out a fixed amount while the variable account is tied to the performance of the stock market or other investments. Sometimes, these accounts can even be a combination of the two.
These accounts are rather like a CD in nature. The interest rate is guaranteed, but is frequently better than the interest paid on most CDs. Predictable payments make retirement planning easy. Investors who feel wary or suspicious of the stock market’s vagaries often choose a fixed account. Moreover, many of these investment tools do not require a large initial investment. Often, something between $1,000 and $10,000 is required to get started. It’s important to keep in mind that the payouts on these type of investments will not keep pace with inflation. Specifically, it’s difficult to predict how much money will be worth many years in the future. The monthly payout that sounds sufficient today may be woefully inadequate 40 years from now, which is something to keep in mind.
A variable account is tied to the specific investments in which you choose to put your money. The interest rate is not guaranteed and there is no set payout amount. The funds may be placed in stocks, bonds, mutual funds and other types of accounts. Because of their variability, these accounts have the potential for tremendous growth. The downside is that they also have the potential to set up investors for massive losses. This means that you’re taking a great deal more risk when you opt for this type of investment. Nonetheless, this can be a good choice if retirement is far into the future and you’ll have plenty of time to make up for any losses you might suffer. The potential for financial growth with these accounts means that your investment just might outpace inflation.
Benefits and Advantages
Several advantages can make an annuity a good choice. Money invested in an annuity is not taxed. When withdrawals are made, taxes will need to be paid on money earned. Many people also make use of the tax deferred benefits received from a 401k and an IRA. However, an annuity has one advantage over these accounts in that there is no annual limit on investments. Where you can reach an annual maximum on a 401k or an IRA, that can never happen with an annuity. The investment compounds every year without the government taking a cut. Plus, the guaranteed payments can bring immense peace of mind during the retirement years. It’s probably best to not withdraw money until at least the age of 59 ½ to avoid penalties.
Are Annuities a Good Investment for Young People?
Annuities can make sense for young investors, especially if they are maxing out contributions to their IRA and 401K. An annuity is just one more way to diversify retirement investing. However, it’s important to understand that annuities come with a great deal more fees and expenses than other types of retirement accounts. Without a sufficiently large investment and favorable interest rate, these investment vehicles simply may not be worthwhile to young people.
When Does this Investment Make Sense for Young People?
Annuities don’t make sense when you’re saving for short-term goals or when you’re not maxing out your 401k and IRA. Nonetheless, if you are financially stable and looking for a way to diversify your portfolio, one of these accounts can make sense. Usually, a variable account will be the most helpful. Because retirement is so far in the future, it’s impossible to predict what inflation will be like when today’s young person is ready for retirement. Plus, young investors are much better able to tolerate risk than older investors because they have plenty of time to make up for losses.
Choosing Fixed Over Variable
Still, some people love the way the word “guaranteed” makes them feel. If you’re maxing out 401k and IRA contributions, a fixed account might provide you with that little extra bit of confidence that enables you to sleep at night. After all, the best annuities are the ones that let you retire on your terms. Talk with a financial advisor and use an online annuity calculator to determine whether or not this investment makes sense to you.