1. What are annuities?
Annuities are financial products designed for retirement planning that people can include as part of their retirement savings strategy. Simply, an annuity is a contract between you and an insurance company. In return for the money you pay to buy the annuity, which is called a premium, the insurance company will give you a series of payments that are guaranteed to last for a period of time you select in advance. An annuity could pay you for your entire life – even if you live to 120 – for your spouse’s entire life, or for a set period of time that you select, depending upon the type of annuity. Additionally, you can withdraw funds from some types of annuities.
2. What are the most common types of annuities?
Variable annuities are long-term financial products designed for retirement planning that allow you to invest in the market. Variable annuities provide you with growth potential when the market is up, but can also mean you can lose money when the market drops.
Fixed deferred annuities guarantee your premium payment and guarantee a fixed annual rate of return for set periods of time until you’re ready to start getting payments.
Immediate annuities allow you to turn a lump sum of money into a stream of guaranteed payments that can last for your lifetime, or a set period of time, depending on your preferences.
Deferred income annuities allow you to take money that you have today and turn it into a guaranteed stream of lifetime payments in the future.
3. How are annuities taxed?
Generally, annuities grow tax-deferred, which means you don’t pay taxes on the earnings until you withdraw them or you convert them to a stream of payments, also known as annuitization. This may mean you get a tax advantage, especially if you don’t begin to make withdrawals or convert your annuity to a stream of payments until you’re in a lower tax bracket (such as when you’re in retirement). It’s good to keep in mind that if you make a withdrawal, any earnings in your contract will be taxable. You may also choose to receive income once you annuitize the contract. If there are earnings in your annuity contract, each payment will be partly taxable and partly a return of your investment once you annuitize.
In addition, there may be tax penalties if you make a withdrawal from your annuity contract before age 59 ½, unless you meet one of the exceptions to the penalty rules. Before making any decisions regarding an annuity, you should seek specific advice from an independent tax, legal, or financial professional.
4. What questions should you ask a financial representatives about annuities?
These are a few things to consider. Annuities are not a liquid investment, which means that your money will be tied up in a contract. With some annuities, you can opt to cancel, or “surrender” the contract to receive the value of your contract, but a surrender charge may be applied if your premium (the money you paid in) was in the annuity for less than a specified number of years. Ask your financial representative about the terms of any surrender charges. Certain annuities may also come with annual fees or additional fees for optional contract features, so ask your representative what fees you’ll have to pay. Some annuities or annuity benefits may be based on market performance, so ask your representative for the details. You’ll also want to know what kind of financial rating your insurance company has. Ratings tell you how financially secure the company is, so you’ll want to make sure you’re purchasing from a trusted insurer so you can feel confident the money will be there when you need it.
5. Are annuities a good investment in addition to other strategies?
As part of the mix in your retirement planning strategy, annuities may help you achieve a greater level of income stability, so that no matter how long you live, you won’t outlive that stream of income. If the income you receive from an annuity can cover your fixed costs, you can spend your other retirement savings with greater confidence.