What Are Annuities?
An annuity is a contract between you and an insurance company in which you agree to commit a certain amount of money in the insurance company’s annuity. In turn, the annuity will make payments to you, either for a fixed number of years, for the rest of your life, or even in a lump sum. Because most annuities offer a guarantee of some kind of income, many people who are concerned about having enough income in retirement find them appealing.
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Which Annuity Is Right For You?
There are many different types of annuities available, including variable, fixed rate, fixed indexed, etc., each having different features. Some of them are popular, including indexed annuities and fixed-rate deferred annuities. Some of this is due to changing demographics. More aging Americans will rely on Social Security and savings for retirement. To earn higher rates than money market accounts and CDs, many are purchasing products with guaranteed growth, according to LIMRA Secure Retirement Institute.
https://www.limra.com/en/newsroom/news-releases/2024/limra-record-high-2023-annuity-sales-driven-by-extraordinary-growth-in-independent-distribution/
Types of Annuities
The different types of annuities fall into four main categories based on when you get the income and how your annuity earns interest.
Immediate Annuities
You make one lump-sum contribution. It’s converted into an ongoing, guaranteed stream of income for a specified period of time (as few as five years) or for a lifetime.
Fixed Annuities
Fixed annuities allow you to lock in a rate of earning that, even over long periods of time, remains unaffected by market ups and downs.
Variable Annuities
Unlike the others, variable annuities are securities products, typically mutual funds invested in stocks, bonds, money market instruments, or some combination of the three.
Fixed Index Annuities
We briefly discussed this type of annuity earlier. Guaranteed never to lose value, each FIA is tied to a stock market index, and it earns interest by participating in a set percentage of that index’s growth.
Annuity Advantages
Protection From Market Downturns
Many people close to retirement are uncomfortable with the risk of volatility in the stock market, and they prefer to place at least a portion of their savings in a more secure product.
Tax Advantages for Growth
Many people consider the tax benefits of annuities one of their greatest attributes: specifically, the interest on annuities grows tax-deferred.
Guaranteed Income for Life
Annuities can be structured to pay out for the life of the owner or for a fixed term, such as five or ten years; this spreads out your tax burden and provides enhanced income security.
FAQ
Annuities are generally safe and are guaranteed by the insurance company that issues them. However, not all annuities are necessarily a good fit or a good deal. It is very important to work with a trusted financial advisor who can compare pros and cons, fees, and costs for you to help you assess suitability based on your unique situation.
When explaining annuities versus other retirement accounts, the main difference is how you withdraw the money. With other accounts, you can take out the money as you would like to. With an annuity, you are receiving the money in payments that are similar to an income structure. This means that it’s more difficult to spend large amounts of your annuity account at once.
The tax process on annuities can be a bit complex. One of the benefits of annuities is that they are taxed as regular income when you begin to withdraw from them, which is fairly familiar to most people. Where it gets complicated is when you fall below the total premium sum that you contributed, the amount is usually not taxed at all. Having a financial advisor to oversee your annuity tax process is always a good idea.
Unfortunately, early annuity withdrawal comes with a 10% penalty. This can be a significant amount of money, especially since you have likely been contributing to this account for most of your life. It is best to contribute money that you know you will not need until you reach 59.5 years of age.
As insurance products, annuities must have listed beneficiaries. This creates a framework and structure for estate planning, but it also, if structured properly, allows that money to pass to beneficiaries without the money being subject to probate.
Take A Deeper Dive
This comprehensive eBook is a straight-forward guide to understanding how annuities work, the various types of annuities, and the questions to ask before purchasing one. Yours for free!
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