What are Annuities?
Updated on May 22 2019
Annuities are a type of investment account typically used for retirement savings or to generate regular income payments in retirement. Annuities are basically insurance contracts where the issuing insurance company provides some type of guarantee on your investment.
Annuities were originally designed to be a reliable means of securing a steady cash flow for an individual during their retirement years to alleviate their fears of outliving their assets. There are many types of annuities and many retirement savings strategies that ensure that you will not run out of money in retirement that do not involve annuity investments. The ideal retirement investment strategy for you depends on your unique situation and your financial goals.
What is the definition of an annuity?
An annuity is a tax-deferred investment contract. The details on how it works vary, but the normal process is that you invest your money, either a lump sum or a series of contributions, with a life insurance company that sells annuities.
The period when you are funding the annuity is known as the ‘accumulation phase.’ In exchange for your investment, the annuity issuer promises to make payments to you or a named beneficiary at some point in the future. The period when you are receiving payments from the annuity is known as the ‘distribution phase.’ Typically, you start receiving payments after you retire.
What type of annuity are possibly good investments approaching retirement?
If you are looking for income in retirement or are still saving for your retirement, check with a financial advisor to determine what retirement savings strategy is best for your particular financial situation. If you and your financial advisor determine that an annuity is the best option for your portfolio, you have several types of annuities to consider:
Income annuities – Income annuities can provide a stable and secure source of retirement income. With these types of annuities, you surrender future access to a portion of your savings in exchange for a stream of income that’s guaranteed for life. Payments from income annuities can typically start as early as thirty days from the day you sign the contract.
A deferred variable annuity (with a lifetime withdrawal benefit) – Deferred variable annuities with lifetime withdrawal benefits offer a way to safely draw down your retirement assets by guaranteeing that, at a minimum, you will be able to withdraw a set percentage of your savings for the rest of your life. You retain access to your savings throughout the life of the annuity, and since the money is invested in a portfolio of stock and bonds, you have the opportunity to grow both your principal and your income stream gradually over time.
Deferred annuities – Deferred annuities’ investments grows tax-deferred, so you won’t owe taxes on your earnings until they’re withdrawn. Depending on the annuity, you can invest in portfolios covering all the major asset classes; giving you a chance at long-term growth. You also have the option to lock in a specific interest rate so that you know exactly what you’ll earn.
What other things do you need to consider when shopping for an annuity?
In addition to the below items, check with a qualified financial advisor to help you with your annuities’ investment.
- The issuer of the annuity – Look for and consider an issuer who is responsible, reliable and has a good track record with annuities.
- The fees and charges associated with the annuity – Costs can have a big impact on the performance of your annuity—and costs vary widely—so it’s important to shop around.
- The financial flexibility and timing payout you desire – Timing payout is quite varied when it comes to the different kinds of annuities, so it’s important to do your homework and choose one with a payout that works well with your financial goals. Keep in mind that payments are based on the claims-paying ability of the issuer. You want to be sure that the payments you receive will meet your income needs during retirement.
What are the pros and cons of annuities?
Annuities, like any investment, come with pros and cons. Consider the benefits and drawbacks of annuities before adding an annuity to your retirement portfolio.
- Your investment earnings are tax-deferred as long as they remain in the annuity.
- An annuity is free from the claims of your creditors in most states.
- If you die with an annuity, the accumulated value will pass to your beneficiary without having to go through probate.
- Your annuity can be a reliable source of retirement income.
- You don’t have to meet income tests or other criteria to invest in an annuity.
- You’re not subject to an annual contribution limit, unlike IRAs and employer-sponsored plans. You can contribute as much or as little as you like in any given year, subject to the annuity contract provisions.
- You’re not required to start taking distributions from an annuity at age 70½, which is the required minimum distribution age for traditional IRAs and employer-sponsored plans.
- You can typically postpone payments until you need the income.
Annuities aren’t for everyone and should be considered on a case-by-case basis. Here are some potential drawbacks.
- Contributions to nonqualified annuities are made with after-tax dollars and are not tax deductible.
- Once you’ve elected to annuitize payments, you usually can’t change them (but there are some exceptions).
- You can take your money from an annuity before you start receiving payments, but your annuity issuer may impose a surrender charge if you withdraw your money within a certain number of years after your original investment.
- You may have to pay other costs when you invest in an annuity, such as fees and insurance expenses.
Is an annuity right for you?
Every investment portfolio is unique for what makes financial sense for an individual’s specific situation. A financial advisor can help you determine whether annuities are an investment that makes sense for you.
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