Annuities
Deferred fixed annuities can help you earn tax-deferred interest and lock in a future stream of retirement income. People in, or near, retirement, often choose them to build income without exposure to stock market volatility.
- Save tax-free
Annuities enable you to save money on a tax-deferred basis. You will not pay taxes until you begin to withdraw your money. Unlike a 401(k) or IRA, there are no limits on the amount you can put into an annuity. - Offers retirement income
You can purchase a contract that provides lifelong income or one that pays you for a specific time. Payments can be monthly, quarterly, semiannually or annually at a designated time. - Provides benefits to your heirs
Some annuities include an insurance component. If you die before you start to collect on the annuity, it pays your heirs the amount you invested plus interest or the market value of the funds in your account, whichever is more. - Offers an array of investment options
You determine how much you want to invest in an annuity and the amount of investment risk you are willing to take. If you put your money into a variable annuity, your premiums can be invested in stock or bond funds. There are no tax consequences if market conditions prompt you to change how your balances are invested. You can also change from one fund to another without tax consequences. If you don't want to deal with the ups and downs of the stock market, you can invest your money in a fixed annuity, which would offer you a specific rate of return.
Why should I consider purchasing an annuity?
You may need to protect yourself against outliving your assets, even if you have diligently saved for your retirement. Consider the following:
- Retirement plans limit contributions
Employer-sponsored plans such as a 401(k), 403(b) or Keogh are an important part of planning for retirement. However, contributions to these plans are limited. - Social security and pensions may not be enough
Your social security and pension may provide less than you need to retire. In 2012, the average Social Security check was $1,230 per month, according to the Social Security Administration and the value of fixed pensions is eroded by inflation. - Inflation and taxes can eat away at savings
Over time, inflation will make everything you purchase more expensive, so your investment earnings need to keep pace to maintain your current standard of living. Many sources of income may also be taxable such as Social Security, IRA payments, interest earned on CDs and savings accounts. You may end up with a lot less after-tax income that you had been expecting.
How much should I invest in an annuity?
The amount of money you should consider putting into an annuity depends on your:
- Current savings and investment portfolio
- Immediate economic needs
- Long-term financial goals
You may need to build retirement savings with a tax-deferred annuity or supplement your retirement savings with an immediate annuity.
Unlike a 401(k) or an IRA, there are no limits on the amount that you can invest in an annuity.
How are annuities different from life insurance?
Both annuities and life insurance should be considered in your long-term financial plan. While both include death benefits, you buy life insurance in the event you die too soon and an annuity if you live too long.
Essentially life insurance provides economic protection to your loved ones if you die before your financial obligations to them are met, while annuities guard against outliving your assets.
Annuities are a retirement planning tool. You can invest in a:
- Deferred annuity: A long-term investment contract that builds savings on a tax-deferred basis.
- Immediate annuity: A type of personal pension plan that is purchased at or near retirement. It offers something that no other investment can guarantee – regular income payments for the rest of your life – no matter how long you live.
Life insurance provides financial protection to your loved ones when you die by providing:
- Income replacement
If you have dependents, then you need to consider what would happen to them if they no longer have your income to rely on. - Payment of outstanding debts and long-term obligations such as burial costs, credit card debts and medical expenses not covered by health insurance. In addition, life insurance can be used to pay off the mortgage, supplement retirement savings and help pay college tuition.
- Estate planning
The proceeds of a life insurance policy can be structured to pay estate taxes so that your heirs will not have to liquidate other assets. - Charitable contributions
You can designate some of the proceeds from your life insurance to go to your favorite charity.
While both life insurance and annuities have death benefits, they are not the same. The purpose of life insurance is to provide death benefits to your loved ones, while the primary goal of an annuity is to supplement retirement savings.
Most annuities (deferred in particular) include a death benefit. Generally, the death benefit is determined by the amount in your account balance when you die.
What are the different types of annuities?
There are many types of annuities for a variety of different needs and budgets. Your age and risk tolerance should weigh heavily in your decision regarding the type of annuity in which to invest.
When considering an annuity, you will have to decide when you want to receive the money. If you invest in an immediate annuity, you would receive the income now, while a deferred annuity would be a savings vehicle for the future.
- Immediate annuity: You pay the insurer a lump sum of money in exchange for receiving income for a set period of time or for as long as you live. You usually start receiving payments immediately after transferring funds into an annuity.
- Deferred annuity: This is a long-term retirement savings vehicle, which builds savings on a tax-deferred basis.
You will also need to select how your money will be invested. You can invest your money so that you get a stable rate of return or you can pick an annuity where your money is invested in the stock market. You can pick one or a combination of the following:
- Fixed annuity: Fixed annuities pay interest on the premium contributed at a rate declared by the insurer in advance.
- Fixed Indexed annuity: Fixed Indexed annuities are a type of fixed annuity. Fixed Indexed annuities usually provide a purchaser with various options for interest crediting. A buyer does have an option to elect a declared interest rate, which generally allows an allocation of anywhere from 0-100% of the account value, and functions the same as a traditional fixed annuity. However, the annuity is designed for higher potential interest rates, and provides other allocation options which consider the performance of an outside stock index (such as the Standard and Poor's 500, a.k.a. S&P 500) to determine the rate of interest. These options pay interest at a rate determined by a formula which considers any increase in the outside index, often subject to a “participation rate”, and/or “cap, and/or "spread”. All indexed annuities have a floor of zero, meaning the absolute worst case scenario due to a downturn in the market index is a consumer might receive no interest in a particular year, however, he or she cannot lose any previously credited interest or premiums.
- Multi-Year Guaranteed annuity: A multi-year guarantee annuity, also referred to as a modern annuity, is a fixed annuity on which the current interest rate is guaranteed for a period longer than one year. Although some multi-year guarantee annuities offer a two-year rate period, these contracts generally offer current interest rates for periods of three to ten years.
