Risk-Free Investing: How Annuities Compare to Other 'Safe' Options

Saving for retirement can provide you with the financial security you need when your working years are behind you. Having a solid retirement planning strategy can mean you have the money to support your lifestyle when you're retired. Of course, the level of risk you're willing to take will determine where you save and invest money for retirement. The best place to invest money without risk is nonexistent because anything you choose to invest money in has some amount of risk. However, annuities are a retirement savings tool offering less risk than many other options.

Annuities differ from other investments in several ways, and one is that they can be a safer way to secure your money. Unlike other investments, an annuity can provide you with a guaranteed income stream. Learning how annuities compare to other investment options will help you determine if this is the an appropriate option for you to save for retirement.

What is an annuity?

An annuity is an insurance product you can contribute money to that provides income payments or a lump sum at some point based on the terms of your contract. There are many types of annuities, which will be discussed more below. The contributions you make to a deferred annuity earn interest, allowing the money to grow. The period in which you can contribute to your annuity is called the accumulation phase. If you wish to receive income, you can then annuitize your contract. This is when your annuity begins to pay out. You can't make any more contributions to your annuity after annuitization.

While an annuity can be a safe way to save for retirement, it's always a good idea to consult with a financial advisor before making any major financial decisions. Annuities often have fees associated with them, so make sure you understand them to ensure your annuity contributions earn you the income you need and want when you retire.

Types of annuities

Knowing the differences between the types of annuities can help you choose one that suits your retirement planning strategy best. Each annuity type has pros and cons. Familiarize yourself with these annuities and their benefits before you talk to your financial advisor so you get the results you want from your retirement plan.

Deferred annuity

With a deferred annuity, you can make contributions during the annuity's accumulation period. Fixed, variable and fixed indexed annuities are deferred annuities.

When it's time to start receiving payments, you'll pay taxes on the income. The taxes you pay are determined by your tax bracket for the total income you receive for the year, including your annuity payments. This is a way to defer paying taxes on some of your income until you retire.

Fixed annuity

With a fixed annuity, an insurance provider provides a fixed interest rate that's determined when you sign the contract. Typically, you won't lose the principal you contribute during the accumulation phase of your fixed annuity. This is why fixed annuities are considered a fairly safe investment.

The downside to this type of annuity is that the potential growth of your money is smaller than it can be with riskier investments. Fixed annuities are often a supplement to other types of investments that come with a higher level of risk.

Variable annuity

A variable annuity differs from a fixed annuity because the money you contribute to this type of annuity is invested in investment accounts similar to mutual funds. The return on your contributions is based on the performance of these accounts. You choose which accounts in which to allocate the money when you set up your annuity and can reallocate it later if your tolerance for risk changes.

This type of annuity has a higher level of risk than a fixed annuity. Of course, you have the potential for higher return than with a fixed annuity. If you decide to take income, the insurance provider determines your payout based on the value of your variable annuity when it's annuitized.

Fixed index annuity

Fixed index annuities combine the features of a fixed annuity and a variable annuity, offering a rate of return based, in part, on the performance of an index such as the S&P 500. This means the risk factor for a fixed index annuity is slightly higher than that of a fixed annuity but lower than what you have with a variable annuity. Because the interest credited to your contributions is tied to the performance of an index, your earnings will fluctuate.

Although there may be years when the index experiences negative performance, the principal in a fixed index annuity is guaranteed not to go down.

However, positive index performance is subject to a cap or participating rates. For instance, if your fixed index annuity has a cap rate of 10% and the market has a performance of -13%, you'll receive 0% gains for the year. But if the market has gains of 13%, you'll still only earn 10% on your annuity that year. A financial advisor can help you better understand whether a fixed index annuity fits your retirement planning strategy.

Immediate annuity

An immediate annuity is one that begins making payments to you immediately after you make a lump-sum contribution to it. This annuity option allows you to receive payments right away, which can continue for life depending on the contract you have with the insurance provider.

Is an annuity the best place to invest money without risk?

Annuities are often considered a safer way to save for retirement than many other types of investments. With many annuities, you never lose the money you initially contribute. This means that even if your contributions don't earn a significant amount of interest, your money is there for you. You can also receive a steady income stream with an annuity, which may last for the rest of your life. Some annuities pay out more than your contribution and interest if you live longer than expected and have guaranteed payments for life.

Another benefit of buying an annuity is the ability to name a beneficiary. This is a person or entity that can receive payments or a lump sum from your annuity if you die before the contract expires. If your beneficiary is your spouse, they can typically take over your annuity and become the annuitant, or owner of the contract, and receive payments until the contract expires. These payments will be the same amount you received unless otherwise specified in your annuity contract.

Annuities vs. other investment options

While an annuity is an insurance product, not an investment, this is an excellent part of a well-rounded retirement plan. You should consider how annuities compare to other investment options that are considered safe, or at least less risky, before creating your retirement investing strategy.

Annuities

Contributing to an annuity is a way to ensure you have a regular income stream at a later date. Your money is backed by the insurance provider to be paid to you in installments or a lump sum at a specified time in the future. Depending on your contract, you may not be able to access the funds without paying a penalty until the date you agree to with the insurance company when you sign the contract, making this a long-term savings option.

Money market funds

A money market fund invests in short-term, stable securities. The returns for money market funds are often minimal, and there's no guarantee on the principal. These funds aren't FDIC insured, but they're considered less risky because they seek to maintain a stable value and you can easily access the money at any time.

Bond funds

A bond fund invests in many different bonds, allowing you to diversify your bond portfolio without having to choose individual bonds yourself. These bond funds typically have low to moderate risk depending on the types of bonds in the fund and how they're managed. 

CDs

Certificates of deposit, or CDs, have long been considered a low-risk place to put your money. A CD requires you to leave your money in it for a set period, in which you gain a fixed amount of interest on the sum. You must purchase a CD through a financial institution, such as your bank. Because you're buying a CD from a bank, it comes with FDIC insurance. You'll never lose the principal amount, and you're guaranteed the fixed interest rate on the CD when it matures.

Choose the right retirement planning strategy

Doing some research and understanding your financial goals will help you choose a retirement planning strategy that works for you. Annuities offer a way to start saving for retirement today, knowing you'll have a guaranteed income in the future. Discuss your options with an expert who can guide you in finding an annuity that meets your needs and gives you peace of mind for your financial security.

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