Understanding the 401k Annuity Option

If you have ever considered purchasing an annuity, 401k accounts are now providing a way for you to purchase them. The 401k annuity is an option that has not always been around, but it is becoming more popular in today's market. Here are the basics of the 401k annuity and how it can benefit you as a retirement investor.

401k Annuities

One of the traditional ways to purchase an annuity was to take a lump sum from your retirement funds and turn it over to an insurance company. These lump sum annuities would then provide investors with fixed payments for the rest of their lives. The only problem with this scenario is that only 1 percent of retirees would actually take this lump sum option. There is a certain psychological block that comes with giving hundreds of thousands of dollars of your retirement money to an insurance company all at once. With the 401k annuity, this problem has been addressed. 401k investors are allowed to devote a certain percentage of the funds from their 401k contributions towards the purchase of an annuity. This provides them with a way to pay for the annuity over their entire working lives instead of all at once. 

What it Provides

By purchasing an annuity with part of the funds from your 401k, you are basically hedging your bet against the failure of your other investments. Many people do not like leaving their retirement up to chance. When you invest in the financial markets, this is essentially what you are doing. It is up to you to choose the right investments and bring in enough money to fund your retirement. With an annuity, you are basically guaranteeing that you will have a certain amount of income once you retire. The annuity company is telling you that if you give them a certain amount of money each month, they will provide you with a paycheck every month for the rest of your life once you retire. Many investors prefer this type of security in their retirement planning. With the 401k option, you can invest some of your money in an annuity and some in traditional 401k investments, such as mutual funds. This provides you with a way to attack retirement planning from multiple angles and increase the odds of living a comfortable life upon retirement.

Interest Rate Risk

One problem that many people have had with traditional annuities over the years is the interest rate risk. With many annuities, you will be paid a rate of interest based upon what interest was when you purchased the annuity. If you decided to buy when interest rates were low, you would not be able to take advantage of increases in interest rates. With the 401k annuity, this should not be an issue for you. You will be able to be paid interest based upon the average of the interest rates over the life of the annuity. This is a better way to calculate the interest rate and will work in your favor.

blog comments powered by Disqus