05 Sep I have extra money. Should I consider an annuity?

Q. I max out my 401(k) and an IRA every year, but I do still have extra money to invest. I was putting it into an index fund, but my uncle said I might be a good candidate for an annuity. I’ve always heard they are expensive but I don’t even know where to start, but I want to understand more before a salesman gets his hands on me. Also I don’t need life insurance. What do you think? What should I know?
— Investor

A. We’re glad to hear you’re saving for retirement so robustly.

It’s also prudent that you’re considering your options for investing your extra money wisely.

Annuities can be a complex financial product and are appropriate in specific circumstances, said Michael Green, a certified financial planner with GYL Financial Synergies in Parsippany.

He said it’s important to have a clear understanding of annuities and how they work before making a decision to purchase one.

“An annuity is a financial product offered by insurance companies,” he said. “In its most basic form, it’s a contract where you invest a lump sum of money, and in return, the insurance company promises to provide you with regular payments, either immediately or in the future.”

There are different types of annuities, each with its own features.

Immediate annuities start paying you as soon as you make your initial investment, while deferred annuities delay payments until a future date, allowing your investment to potentially grow, Green said.

Deferred annuities can further be categorized into fixed annuities, variable annuities and fixed index annuities, he said.

Fixed annuities offer a fixed interest rate for a specific period. Variable annuities allow you to invest in various sub-accounts similar to mutual funds. The returns are based on the performance of the investments you choose. Lastly, fixed index annuities offer a minimum guaranteed interest rate along with the opportunity to earn interest based on the performance of an underlying market index, he said.

“Annuities can come with various fees, including administrative fees, surrender fees, mortality and expense fees, and investment management fees for variable annuities, to name a few,” he said. “These fees can eat into your potential returns over time. It’s important to fully understand the fee structure before committing to an annuity purchase.”

It’s also important to know that annuities often come with surrender charges if you want to withdraw more than a certain percentage within a specified period, usually the first few years, Green said. This can limit your access to your money, he said.

Green said annuities can be suitable for some individuals seeking a guaranteed income stream during retirement. They might not be the best option if you’re looking for growth potential or have a long investment horizon, he said.

“Before making any decisions, you should consult with a fee-only financial advisor who doesn’t earn commissions from selling financial products,” he said. “They can provide customized, personalized advice based on your specific financial situation and goals. In addition, there are likely other options available that you may not have considered.”

Given that you’re already maxing out your 401(k) and IRA, it’s essential to carefully weigh the pros and cons of an annuity in light of your financial goals, risk tolerance and overall investment strategy, Green said.

“Make sure you fully understand the terms, fees, limitations, and potential benefits before committing to such a significant financial product,” he said. “Finally, this decision should be made as part of a comprehensive financial plan that takes your entire financial situation into account.”

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This story was originally published on Sept. 5, 2023.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.