The Annuity Income Retirement Guide
- What are annuities?
- Types of annuities
- How annuities work
- Pros and cons of annuities
- How to determine which annuity is right for you
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What Are Annuities?
Annuities are insurance contracts that make regular payments to you either immediately (Immediate Annuity) or at some point in the future (Deferred Annuity) depending on the type you purchase. You buy an annuity by making either a single payment or a series of payments. Similarly, your payout may come either as one lump-sum payment or as a series of payments over time.
There are a number of annuity types, allowing you to find which one fits your needs and comfort level. You can also purchase a variety of contract provisions, known as riders, to modify the annuity to further customize it.
What Types Of Annuities Are There?
There are three basic types of annuities, fixed, variable and indexed. Here is how they work:
Fixed annuity.
This is the option with the least risk and the most predictability. Fixed annuities come with a guaranteed, set interest rate that doesn't vary beyond the terms of the contract. While other investments might soar or dive, the fixed annuity is steady. Sometimes, however, the interest rate will reset after a predetermined number of years.
Variable annuity.
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.
Indexed annuity.
Indexed annuities, also known as equity-indexed annuities and fixed-indexed insurance products, have characteristics of both fixed and variable annuities. It's a way to balance the risks and rewards, carrying lower risks than variable annuities and higher income potential than fixed annuities. So the interest rate won't sink below a preset amount. But the rate is also tied to a specified index, such as a stock market index, and can rise higher than a fixed annuity. The tradeoff is that this kind of annuity also has higher costs and fees than a fixed annuity has.
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Are Annuities Safe?
By and large, annuities are a safe investment. However, it's important with annuities to purchase them from highly rated, well-established insurance and financial services companies with good reputations.
That's partly because, unlike certificates of deposit, annuities are not insured by the Federal Deposit Insurance Corporation.
However, all states have guaranty associations that insure at least partially against the failure of annuity providers.
The Pros and Cons of Annuities
Remember, there are a few different types of annuities with an almost unlimited amount of combinations you can create, including the riders you can add to them (Long-Term Care, Death Benefit, etc.). With that said, there are some common pros and cons to Annuities overall that you should be aware of:
The Pros
- Annuities can provide lifelong income.
- Taxes on deferred annuities are only due upon the withdrawal of funds.
- Fixed annuities guarantee a rate of return, which translates into a steady income stream.
- Indexed annuities credit interest to your contract without market downside risk.
The Cons
- They're complex and hard to understand.
- Fees make annuities more expensive than other retirement investments.
- Net returns on withdrawals are taxed as ordinary income.
- Returns of an annuity may not match traditional investment returns
Why To Consider Indexed Annuities
With an indexed annuity, the company will credit you the return that is calculated by the changes on a certain index, such as the S&P 500, but without actually having your money in the market. It will also guarantee you a minimum return, though these minimums can vary from one company to the next. Some of the benefits of an indexed annuity include:
- You can use the funds to build up money on a tax-deferred basis (where you pay the taxes once you withdraw the money).
- You can withdraw up to 10% a year of the original amount you invested without penalty.
- You can add a death benefit where, if you die early, the annuity will go to your beneficiary and avoid probate altogether.
- You can also pull out up to 100% of the annuity without penalty if you are forced to go into a nursing home.
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