If your elderly parents don’t have a pension, having a steady source of retirement income, like an annuity, can provide financial security. According to AARP, annuity sales reached $385 billion in 2023, reflecting their growing popularity.
Before purchasing an annuity for your parents, it’s crucial to understand potential drawbacks and complexities. This guide explains what annuities are, how they function, and how to select the right one for your parents’ needs.
Key Takeaways
Annuities are a way to guarantee a steady stream of predictable income during retirement.
Annuities are considered low-risk investments with guaranteed returns.
Annuities are tax-deferred, so taxes are paid only at withdrawal.
What Is an Annuity, and How Does It Work for Seniors?
Cody Barbo, the CEO at Trust & Will, explains: “An annuity is essentially an insurance product that can provide seniors with a steady income stream, often viewed as a way to manage longevity risk.
"The idea is that you pay into an annuity either through a lump sum or a series of payments, and then the annuity pays you back on a regular schedule, typically for the rest of your life.”
Annuities are a practical retirement strategy for seniors without employer pensions. They are low-risk investments available through insurance providers, brokerage firms, and banks.
How the Process Works
The owner pays a lump sum to an insurance company or another provider from whom they purchase the annuity. The company invests this money, allowing the annuity account to earn interest over time.
Depending on the chosen payout arrangement, the annuitant (the person receiving payments) can receive regular disbursements that include both the original amount and the earned interest. While the returns may not be as high as those from stocks or bonds due to commissions and fees, annuities are considered a low-risk option that can provide additional income to supplement Social Security benefits.
You can keep track of your parents’ earnings and investments with a secure digital vault like Trustworthy. Trustworthy’s Family Operating System® can be used to store your digital documents in a secure but easily accessible location.
Types of Annuities Available for Elderly Parents
There’s no one-size-fits-all solution with annuities, which is why various types are available to meet different needs. Choosing the right one depends on your parents’ financial goals.
The first category of annuities decides on when you will start receiving payments:
Immediate: Payments will begin within one year and continue for as long as they live. The only problem is that this requires a large upfront payment because there is little growth within one year.
Deferred: Payments will only start on a preset date in the future to allow the funds to grow in a tax-deferred account. This is not a good option for those looking for an immediate income or wanting to withdraw funds for an emergency.
Once you choose when your parents will receive payments, you’ll need to choose an annuity based on how they are invested. There are three options available for seniors:
Fixed: There is a minimum interest rate set for 10 years for more predictable payments. However, the investment returns are lower than those of other annuities.
Variable: The payouts are based on the performance of stocks and bonds, which means there is a potential for a higher payout. However, market risks can mean lower returns.
Indexed: There are minimum guaranteed rates with an additional possibility of high returns based on an index.
So, which is the best one for your elderly parents? Some of the most popular annuities for seniors are fixed annuities with a lower risk because their income will not be impacted by market volatility and immediate annuities with a lifetime guaranteed option.
Related: Guide to Helping Elderly Parents
Pros and Cons of Annuities for Elderly Parents
Choosing whether annuities are a good idea for your elderly parents means researching the pros and cons because not all annuities are right for everyone.
Pros of annuities
An annuity can supplement your parents’ retirement income while providing opportunities for tax-deferred growth. Some benefits of annuities include:
Regular payments: The biggest benefit of an annuity is regular and guaranteed payments. These payments can increase in value depending on what type of annuity you choose.
Growth is tax-deferred: Unlike other retirement investments, where you must pay tax once the money has matured, annuities do not require tax to be paid until the funds are withdrawn.
Guaranteed rates: If you choose a fixed type of annuity, there’s a guaranteed rate of return. This results in a reliable and predictable stream of income for elderly people.
Death benefit: With variable annuities, there is an additional perk known as death benefit, when the annuity provider makes payments to the beneficiary should the annuity recipient pass away.
Cons of annuities
While annuities offer benefits, certain drawbacks could outweigh them, such as:
Lack of liquidity: Many people are not aware of the surrender period, which can last anywhere between six and eight years, which makes backing out of the signed contract very difficult and costly. If your parents withdraw funds during the first few years of the contract (the surrender period), they may incur a surrender fee.
High fees: Don’t forget to take into account the fees paid with annuities, especially if annuities are bought through an agent and not directly from an insurer. Some administrative fees can cost about 1% to 1.25% of your account’s value.
Returns may not match the investment: Indexed annuities can see capped gains that result in minimal growth, especially when annuity fees are applied or fixed annuities with a minimum guaranteed interest rate of 0%.
Getting out of an annuity can be difficult: If your parents sign an immediate annuity, getting that money they contributed to the fund can be difficult, and if they decide to move that money to a different annuity, they may incur hefty fees.
How Annuities Provide a Steady Income Stream
Annuities can provide a steady stream of income for retirement because they’re a fixed financial contract between the buyer and the insurance company.
Regardless of the type of annuity, your parents will get guaranteed payments. The only thing that may not be guaranteed is the rate of return with an indexed annuity.
Annuities can be structured in a way that provides an income for a set period, like 10-20 years or the owner’s entire life.
What does this look like in real life?
According to ImmediateAnnuities.com, an online buyers guide for annuity shoppers, if a 65-year-old man invested around $100,000 in an immediate annuity, he could get $621 per month for the rest of his life. While it may not be a lot, when combined with Social Security benefits, it could create a livable income.
You can track of your parents’ income and investments by using the finance tab on Trustworthy. The features allow you to ensure all payments are made, and all money is accounted for.
Tax Implications of Annuities for Seniors
As previously mentioned, annuities are taxed only on the amount withdrawn, and the amount of tax is dependent on the type of annuity and its purpose.
For tax purposes, annuities are either classified as qualified or non-qualified.
Qualified annuities: The account is funded with pre-tax dollars through employer-sponsored retirement plans like an IRA, so tax is only paid on the withdrawn amount
Non-qualified annuities: The account is funded by after-tax dollars, so the only income tax paid upon withdrawal is the earnings from interest, not the initial investment
Income from annuities must be reported to the IRS using Form 1099-R when filing your parents’ tax return.
Fees and Costs Associated with Annuities
When purchasing an annuity for your elderly parents, it’s crucial to carefully evaluate the associated fees and costs, as these can significantly reduce the overall returns they’ll receive.
If annuities are purchased through an agent – a common practice – commissions must be paid, and the rates vary by annuity type. Fixed and indexed annuities often carry the highest commission fees, ranging from 6% to 8%, but they could be even higher.
Regardless of whether the annuity is purchased directly or through an agent, annual administrative fees are typically required. These fees generally amount to no more than 0.30% of the account’s value but can still impact long-term returns.
Additional features, such as death benefits or riders, come with extra fees. Death benefits may cost between 0.50% and 1.5% of the account value, while riders – offering guarantees like minimum living benefits – typically range from 0.25% to 1.00% annually.
How to Choose the Best Annuity Provider
When selecting an annuity provider for your elderly parent, consider the following factors:
Payout start: Decide whether payments should begin immediately or at a future date, depending on their financial needs.
Rate of return: Evaluate the level of risk your parents are comfortable with and the expected returns.
Payout options: Determine the duration of payments—whether for a fixed period or their lifetime.
Fees and commissions: Compare providers to identify options with lower costs to maximize the overall return.
If you’re unsure which provider to choose, it’s a good idea to consult a licensed agent or annuity advisor for some advice. Trustworthy can connect you with a Trustworthy Certified Expert™ in your area, so you can get professional advice to ensure your parents have an annuity that works for them.
Frequently Asked Questions
Are annuity payments affected by the financial stability of the insurance company?
Yes, annuity payments depend on the financial stability of the insurance company. To ensure reliability, select a provider with strong financial ratings from agencies like A.M. Best or Moody’s.
What happens to the annuity if my parents pass away?
The outcome depends on the type of annuity. If a death benefit is included, payments may continue to a designated beneficiary. Without this feature, payments typically stop upon the annuitant’s death.
Who should not buy an annuity?
Individuals with limited financial resources may want to avoid annuities, as these products require significant upfront investment and can restrict access to liquid funds.
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