If you’re looking for a way to increase tax-advantaged savings, along with a future income generator, an annuity may be a good option for you. One type of annuity in particular – the “buffer” annuity – can provide you with the opportunity for more growth than a regular fixed annuity, as well as a certain amount of downside protection.
But just like any other “big ticket” item, it is essential that you have a good understanding of how buffer annuities work, and what you can expect them to do (and not to do) for you, both before and after you retire.
What is a Buffer Annuity and How Does One Work?
Buffer annuities allow you to take part in the growth of one or more underlying market indexes (such as the S&P 500), while at the same time keeping your account from incurring a set amount of loss.
In many ways, buffer annuities are structured like regular fixed indexed annuities, except in the case of a buffer annuity, your principal is not protected from 100% of any downward movement.
For example, a buffer annuity may offer protection from a 20% negative return. However, if the underlying index falls by 28% in a given contract year, the insurance company would absorb the first 20%, and you would take the remainder of the loss (in this case, 8%).
Advantages and Drawbacks of Owning a Buffer Annuity
While fixed indexed annuities have become more common over the past decade or so, buffer annuities are still relatively new to the financial marketplace. So, unless your financial advisor is an annuity or retirement income specialist, he or she may not be aware of all the potential advantages and drawbacks of these financial vehicles.
Unfortunately, once you’ve purchased an annuity, it can be somewhat difficult to get out of – at least not without incurring a surrender charge. So, knowing what you can anticipate from a buffer annuity is crucial.
On the plus side, you can typically participate in a larger percentage of the index-linked return with a buffer annuity versus a regular fixed indexed product. On the other hand, though, buffer annuities can still be subject to some amount of loss, whereas fixed indexed annuities can protect your principal regardless of how far the tracked index(es) falls during a given contract year.
As with other types of annuities, the growth that takes place inside of a buffer annuity is tax-deferred. This means that you owe no taxes on the gains until the time of withdrawal. This, in turn, can allow your annuity’s contract value to compound over time (taking into consideration any losses that are incurred with a buffer annuity).
If you’re leaning towards the purchase of an annuity so you can rely on income in retirement, a buffer annuity may be more unpredictable here, too. That’s because any losses to the account value can also impact the amount of income that you receive down the road.
Pros and Cons of Buffer Annuities
|Buffer Annuity Advantages||Buffer Annuity Drawbacks|
|Opportunity for market-linked growth||Limited growth (may be “capped” at a set percentage)|
|Some protection of principal||Can still incur some amount of loss|
|Tax-deferred gains||Loss to principal can also impact the amount of future income generated|
|Future income stream||Highly complex|
Items to Consider Before Buying a Buffer Annuity
All financial decisions should be carefully considered before moving forward. One reason for this is the fact that you will usually incur at least some type of penalty if you cash out of the product “early” (or within a certain time period).
In the case of a buffer annuity, there are several items to consider, such as:
- Short and long-term financial objectives
- Risk tolerance
- Time frame until retirement
- Future income needs
- Other retirement income-generating sources
- Insurance company’s ratings (which reflect the carrier’s financial strength and stability, and its reputation for paying out claims)
Is a Buffer Annuity Right for You?
If you’re considering a buffer annuity, but you still have questions regarding how these financial vehicles work, and whether or not purchasing one would be the right strategy for you, Annuity Gator can help.
At Annuity Gator, our mission is to educate consumers (and financial advisors) about how annuities work, which annuities may (or may not) be a good fit, and what to look for before you make a long-term financial commitment.
So, if you’d like to chat, feel free to reach out to us directly by phone at (888) 440-2468, or send us an email with any questions that you may have and one of our annuity specialists will be happy to help. We look forward to hearing from you.