Investing in annuities is a great fit for retirees looking for a guaranteed, fixed return on their money.
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More About Annuities Continue reading to learn more about: How annuities work
Pros & cons of annuities
Different types of annuities
How to calculate an annuity
Other facts about annuities
What is an Annuity?
An annuity is a kind of pension plan. It allows you to invest a lump sum of money in exchange for regular payments over a long period of time. Annuities can reduce the risk that you will outlive your savings or that a financial collapse might reduce their value. You may be able to choose how often you receive these payments, and you may get extra income if you live longer than expected.
An annuity is a contract between an investor and an insurance company. The investor deposits a lump sum amount, and in turn receives fixed monthly payments over many years, no matter how long he or she lives. It can be useful as either an investment or a retirement tool, as with most protective financial instruments, for people who are worried about the value of their pension funds or pools of savings wavering in the market.
Annuities for Retirement
Regardless of your financial goals and status, everyone needs to have a plan for retirement. A recent study shows that 64% of Americans aren’t prepared for retirement and more troubling is the fact that 48% don’t even care.
An annuity for retirement is the method of investing money in a way that guarantees you a set amount of income for the rest of your life. Annuities are typically purchased using dollars from a 401(k) or an IRA or on after-tax dollars.
How Annuities Work
This is the building phase when investors pay premiumes to build their annuity base.
The income stream that eventually comes from annuity payments.
Fixed & Variable Rates
Depending on the annuity, payout rates can either be fixed or float based on financial market performance.
Riders create the annuity contract (usually with fees) that allow for beneficiaries, inheritance and guaranteed income streams.
After accumulation and annuitization, the insurance company provides regular payouts to the annuity owner.
When annuities are paid with pre-tax dollars, income tax is typically aid during payout when income is presumably lower. When paid with post-tax dollars taxes are only paid on earnings, not the full payout.
Fixed Annuities Fixed annuities are a type of investment that can offer guaranteed rates of interest for a number of years, often between three and ten. As with other investments, you must pay a premium upfront. Returns depend on the performance of the stock market, so is best suited to those who believe in consistent long-term growth.
Variable Annuities Variable annuities include immediate tax benefits, or if your ultimate goal is maximizing withdrawals on an annual basis. You can not choose the underlying investment vehicles, but they consist of a mixture of bonds, stocks and/or fixed interest accounts. The value of the fund will rise and fall in line with the market. Because variable annuities are "contracts of insurance," no separate account is established, and therefore there will be no separate account value available for withdrawal.
AnnuityProsAnnuities may be the simplest and most effective way to provide income as you retire. Many people overlook annuities because they're unfamiliar with them, or—like a 401(k) account—they don't see the value. However, your employer won't be there for you when you retire. Annuities are important because they guarantee recurring payments for either a specific period of time or the rest of your life.
Most annuities include premium protection. Premium-protected annuities mean you will never lose your initial investment.
AnnuityConsAnnuities provide lifetime financial security in exchange for sacrificing a certain level of liquidity. If your short-term or long-term goals are limiting your cash flow, an annuity is most likely not the best financial option for you. After all, when you don’t find a product that’s valuable or viable for you, it doesn’t make much sense for you to purchase it.
A criticism of annuities is that they hold back returns. This is also known as “opportunity cost,” where you are limited to just one investment option, which may not yield much profit through the annuity. Younger investors can reap more returns if they take the risk and invest in other ventures. Older investors typically don’t like to take risks, and find that a guaranteed return works well for them.
Immediate Payouts vs. Deferred Payouts
It’s important to understand whether you will receive immediate or deferred payouts. Your choice will depend on several factors, including the age at which you purchased the annuity, your savings status, and what type of annuity you have.
Immediate annuities give you a lump sum to invest and begin receiving regular income right away. Immediate annuities have no accumulation phase and make up about 10 percent of annuity sales.
A deferred payout annuity allows you to receive distributions at any age following the accumulation (accumulation phase). During the accumulation phase, premiums are invested and grow over time on a tax-deferred basis to lower tax liabilities when your income is at its highest, and provide an opportunity to pay income taxes at a lower level.