Carefully planning your finances is crucial in helping you reach your goals, keep your expenses under control, and make the most out of your money. For firefighters, it’s doubly important, if not more so: Younger retirement ages, insufficient pensions, and higher medical expenses can form a whirlwind of financial problems that could become insurmountable – if you don’t have a plan to deal with them.
Annuities may be the solution to fill any income gaps that appear in retirement. However, annuities are complex products that come in many forms, some of which may not suit firefighters’ unique financial needs. In this article, we aim to provide a clear understanding of the two types of annuities we feel can make the most remarkable difference in firefighters’ retirements: variable and indexed annuities.
Understanding Annuities
Annuities are financial products designed to provide individuals with a steady income stream during retirement. They are a contract between an individual and an insurance company, where the individual makes a lump sum payment or a series of payments. In return, the insurance company agrees to make regular payments to the individual, starting either immediately or at a future date.
What are Variable Annuities?
Variable annuities have returns that are, as the name suggests, variable. They achieve this variability via their ‘investment’ options. The firm that sold you your annuity places your premiums in sub-accounts, from which you can purchase various investments, such as mutual funds composed of stocks, bonds, and money market instruments.
Your annuity’s growth is tied to the performance of these sub-accounts, which means your returns can vary. If the underlying assets perform well, the value of your annuity will increase, and vice versa.
How Variable Annuities Work
During the accumulation phase, you make payments into your annuity, and the money grows tax-deferred based on the performance of your chosen sub-accounts. When you’re ready to retire, you can ‘annuitize’ your contract, which means you’ll start receiving regular payments from the insurance company. The amount of these payments will depend on the value of your annuity at the time of annuitization.
Pros and Cons of Variable Annuities
Potential for High Returns: One of the main advantages of variable annuities is the potential for high returns. If your sub-accounts perform well, your annuity value can grow significantly.
Risk of Investment Loss: On the flip side, the potential for high returns comes with the risk of investment loss. If your sub-accounts perform poorly, the value of your annuity can decrease.
Tax Benefits: Like other annuities, variable annuities offer tax-deferred growth. You won’t pay taxes on that growth until you start receiving payments, which could be a boon for you if you’re in a lower tax bracket in retirement.
What are Indexed Annuities?
Indexed annuities combine elements of fixed and variable annuities. Like fixed annuities, they provide a guaranteed minimum return but also offer the potential for higher returns based on the performance of a market index, similar to variable annuities. However, unlike variable annuities, your money is not directly exposed to the market, which means you’re protected from market losses.
How Indexed Annuities Work
During the accumulation phase, the insurance company credits your annuity with a return based on the performance of the linked market index, such as the S&P 500. If the index performs well, your annuity will earn a higher return, up to a certain cap. If the index performs poorly, you won’t lose any money, and you’ll still receive the guaranteed minimum return. When you’re ready to retire, you can annuitize your contract and start receiving regular payments.
Pros and Cons of Indexed Annuities
Guaranteed Minimum Return: Indexed annuities stand out from variable annuities with their guaranteed minimum return. This stability allows you to plan your retirement finances more accurately. For those who are risk-averse, it provides peace of mind knowing that your savings will eventually be there for you.
Limited Growth Potential: If the underlying index achieves spectacular performance, you’ll only capture a portion of the growth. This is the price you pay for guaranteed returns.
Tax Benefits: Like variable annuities, you don’t pay taxes on your growth until you begin receiving payments, allowing the value to grow unhindered by tax drag.
Variable vs Indexed Annuities: What’s Best For You?
Choosing the correct annuity can be the difference between a successful and unsuccessful retirement, so you have to get it right. A careful analysis of your financial needs and risk appetite is crucial to help you make the correct choice. A bird’s eye comparison of the two can give you a better idea of the differences before sitting down with a financial professional.
Variable annuities carry a higher level of risk than indexed annuities—it’s as simple as that. If you’re risk-averse and can’t afford to let market performance negatively affect your savings, perhaps a fixed-indexed annuity is the right option.
However, suppose you’re younger and have lots of time to let your annuity grow and recover from market losses, and the potential for greater returns is your primary goal. In that case, a variable annuity may be the way to go.
Another way to look at it is control – with a variable annuity, you have greater control over where your money goes, allowing you to choose the investment options that align with your risk profile and growth appetite.
Importance of Consulting with a Financial Professional
Annuities are complex financial products, and you shouldn’t decide without consulting with an expert who knows their ins and outs. Each annuity comes with its own set of fees, charges, and conditions that may not be appropriate for your financial situation. You may also have the option to tack on certain ‘riders’ that expand the parameters of your annuity, such as death benefits and living benefits, and for variable annuities, guaranteed minimum returns. However, they come at additional costs and conditions.
Final Thoughts
If you’re still uncertain about which annuity is right for you or even if you need one at all, you’re not alone. It can be challenging to combine your risk tolerance, financial situation, and retirement goals into a clear assessment that aligns with a specific annuity. This is a complex task that we don’t recommend you tackle on your own, as there’s simply too much at stake.
Instead, we encourage firefighters to take the time to understand their options and make informed decisions about their retirement planning with a financial professional who has the experience and knowledge to get the job done right.
Don’t wait to start planning for your future. Reach out today to explore more resources and learn more about variable and indexed annuities and how they can contribute to your retirement planning strategy.
