Annuities 101

What are Annuities?

Annuities are long-term retirement savings vehicles issued by an insurance company. Annuities can be converted into an income stream that is guaranteed to last for your lifetime. There are many types of annuities but a simple way to begin categorizing them is based on when the annuity contract begins making payments.

  • Deferred Annuity – Payments do not begin for at least 1 year. While all annuity contracts can be converted into an income stream, oftentimes deferred annuities are used as a safe accumulation tool and never converted into income payments.
  • Immediate Annuities – Immediate annuities begin to pay you payments within the first year of purchasing the contract.
Infographic show two the stages of annuities: accumulation and distribution

Types of Annuities

Fixed Index Annuity

Fixed Index Annuities earn interest based on the performance of an external stock market index, such as the S&P 500. These annuities offer the potential for higher returns than fixed annuities and still provide principal protection. The tradeoff is your annuity will be credited zero percent interest in years the stock market goes down.

Fixed indexed annuities on the investment continuum

Fixed Annuity

Fixed annuities provide investors with a guaranteed interest rate which is assured by the insurance company.

With a deferred fixed annuity, the insurance company promises to pay no less than a specified interest rate during the period when the account is growing. In contrast, an immediate fixed annuity, or “annuitizing” a deferred annuity, results in a predetermined fixed amount of money paid out regularly, typically on a monthly basis, resembling a pension. 

Fixed annuities’ predictability makes them a popular option for investors seeking a guaranteed income stream to complement their other investment and retirement income sources. Since fixed annuity payouts are unaffected by market fluctuations, they offer investors peace of mind by ensuring they have a predetermined amount of money to cover future expenses and sustain them throughout retirement.

Single Premium Immediate Annuity

As the name suggests, an immediate annuity provides a steady stream of income shortly after an investor purchases a contract, usually within 30 days, and always within 13 months.

An immediate annuity is a contract between an investor and an insurance company, where the investor pays a lump sum to the insurer in exchange for regular income payments. The payments may be made monthly, quarterly, semi-annually, or annually, and are guaranteed to last as long as the contract holder is alive or for a set period such as 10 or 20 years.

With this type of annuity, you guarantee that your income payments will remain the same regardless of market conditions; however, it comes at the cost of potentially lower returns compared to investing in the markets.

Retirees with a high-risk tolerance and the ability to absorb risk may prefer other investments, including stocks, mutual funds, and bonds. In general, individuals who expect to live longer-than-average lives may benefit the most from immediate annuities.

Researching and shopping around for different immediate annuity features is crucial, as insurance companies may offer varying features for the same lump sum payment.

Variable Annuities

A variable annuity comes with more risks and potentially higher rewards. The interest rate of variable annuities is tied to an investment portfolio. Payments from variable annuities can increase if the portfolio does well, but they can also decrease if the investments lose money.

Why Should You Buy an Annuity?

Annuities come with unique features that make them an attractive option for retirement planning. They offer tax-deferred growth, meaning you don’t have to pay taxes on the earnings until you withdraw the money. 

Additionally, annuities can be customized to suit your preferences, offering choices in payout options and even providing death benefits for your beneficiaries.

Key Features and Characteristics

Annuities offer several benefits that make them worth considering for retirement planning. Here are some compelling reasons to buy an annuity:

Retirement Income Stability

One of the primary advantages of annuities is their ability to provide a stable income stream during retirement. By opting for a lifetime income option, you can rest assured that you’ll have a consistent source of income to cover your living expenses, regardless of how long you live. This stability can help alleviate concerns about outliving your savings and provide peace of mind in retirement.

Tax Advantages

Annuities offer tax advantages that can be beneficial for retirement planning. During the accumulation phase, your contributions grow on a tax-deferred basis, meaning you don’t pay taxes on the earnings until you start withdrawing the money. This tax deferral allows your investment to potentially grow faster compared to taxable investments. However, it’s important to note that withdrawals from annuities are subject to ordinary income tax.

Investment Control and Flexibility

Depending on the type of annuity you choose, you may have control over how your contributions are invested. Variable annuities, for example, allow you to allocate your funds among different investment options. This flexibility enables you to potentially earn higher returns by taking advantage of market opportunities.

Death Benefit for Beneficiaries

Annuities can provide a death benefit to your beneficiaries. If you pass away before receiving the full value of your annuity, a death benefit can be paid out to your loved ones. This ensures that your contributions and any accumulated earnings are not lost and can be passed on to your heirs.

Now that you understand the benefits of annuities, let’s discuss how and where you can purchase one.

How and Where to Buy Annuities

There are various avenues through which you can buy annuities. Here are some common options to consider:

Insurance Companies and Financial Institutions

Insurance companies are the primary providers of annuities. They offer a range of products and can guide you through the selection process. Additionally, many financial institutions, such as banks and credit unions, also offer annuities as part of their investment offerings.

Independent Financial Advisors

Working with an independent financial advisor can be beneficial when buying annuities. These professionals have in-depth knowledge of different annuity products in the market and can help you find the one that aligns with your retirement goals and risk tolerance. They provide personalized advice and recommendations tailored to your specific needs.

Online Annuity Marketplaces

Online annuity marketplaces have emerged as a convenient option for purchasing annuities. These platforms allow you to compare different annuity products, access customer reviews, and get quotes from multiple providers. However, it’s crucial to ensure that the online marketplace is reputable and trustworthy before making any financial decisions.

When shopping for annuities, keep the following tips and guidelines in mind:

Tips and Guide for Shopping Annuities

Assessing Your Retirement Needs

Before purchasing an annuity, evaluate your retirement goals and financial situation. Consider factors such as your desired income level, estimated retirement expenses, and the length of time you expect to need income from the annuity. This assessment will help you determine the type of annuity and payout option that best aligns with your retirement objectives.

Review Fees and Charges

Annuities often come with various fees and charges, including annual maintenance fees, surrender charges for early withdrawals, and investment management fees for variable annuities. Make sure you understand the fee structure associated with the annuity you’re considering and how it may impact your overall returns.

Evaluating Payout Options and Riders

Carefully review the different payout options available for the annuity. Consider whether you prefer a fixed payment amount, inflation-adjusted payments, or a lifetime income stream. 

Additionally, explore any optional riders that can enhance the annuity’s features, such as long-term care benefits or guaranteed minimum withdrawal benefits. Assess these options based on your specific needs and priorities.

Comparing Annuity Providers

When selecting an annuity provider, compare factors such as financial strength, reputation, customer service, and the variety of annuity products they offer. Look for providers with a solid track record, positive customer reviews, and a strong financial standing to ensure the reliability and stability of your annuity.

Now that we have covered the tips and guidelines for shopping annuities, let’s discuss the pros and cons associated with these financial instruments.

Pros and Cons of Annuities

As with any investment product, annuities have their advantages and disadvantages. Let’s explore both sides to help you make an informed decision:

Pros of an Annuity

  1. Steady Retirement Income: Annuities offer a reliable income stream, providing a sense of financial security during retirement.
  2. Tax Advantages: The tax-deferred growth of annuities can lead to faster accumulation of wealth and potentially lower tax liability.
  3. Investment Options: Variable annuities allow for investment control and the potential to earn higher returns based on market performance.
  4. Death Benefit: Annuities can provide a death benefit, ensuring that your contributions and earnings are passed on to your beneficiaries.

Cons of an Annuity

  1. Lack of Liquidity: Annuities are long-term investments, often imposing penalties for early withdrawals. Make sure to consider your liquidity needs before committing to an annuity.
  2. Fees and Charges: Annuities can come with various fees, including administrative fees, mortality, and expense charges, and investment management fees. These costs can affect the overall returns of the annuity.
  3. Loss of Control: Annuities limit your access to the invested funds, potentially restricting your ability to make other investment choices.
  4. Complexity and Transparency: The terms and conditions of annuities can be complex, making it important to fully understand the details of the contract before making a purchase.

Frequently Asked Questions (FAQs)

Q: What happens to an annuity when the contract holder passes away?

A: The treatment of annuities after the contract holder’s death depends on the type of annuity and the options chosen. In some cases, the remaining balance may be paid to the beneficiary, while in others, the annuity payments may cease. It’s essential to review the terms of the annuity contract and consider options that provide a death benefit for your beneficiaries.

Q: Can I withdraw money from an annuity before reaching retirement age?

A: Yes, but early withdrawals from annuities may be subject to surrender charges and tax penalties. It’s important to carefully consider the implications of early withdrawals and assess your liquidity needs before making any decisions.

Q: Are annuities guaranteed by the government?

A: Annuities are not guaranteed by the government. Instead, the guarantees are provided by the issuing insurance company. Before purchasing an annuity, it’s crucial to research the financial strength and stability of the insurance company to ensure they can honor their commitments.

Final Words and Thoughts

In conclusion, annuities can be valuable tools for middle-class individuals nearing retirement age. They offer a stable income stream, tax advantages, and the potential for investment growth. 

By understanding the different types, benefits, and considerations when shopping for annuities, you can make an informed decision that aligns with your retirement goals and financial needs.

Remember to assess your retirement needs, compare annuity providers, and carefully review the terms and conditions before making a purchase. Consult with financial professionals, such as independent advisors, to gain personalized advice based on your unique circumstances.

Secure your financial future by exploring annuities as a part of your retirement plan. With careful planning and consideration, annuities can play a crucial role in providing you with a comfortable and worry-free retirement lifestyle.

Are Annuities Right for You?

An annuity can be a useful tool for retirement planning. However, it’s important to carefully consider what type of annuity best meets your needs as well as the associated fees and risks. Schedule a call with a My Annuity Store professional to discuss your individual goals and objectives to whether an annuity may be right for you.

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