Annuities... What Are They?
An annuity, generally, is a payment received at regular intervals.
Annuities typically are sold and backed by life insurance companies. You can establish an annuity contract to put aside money for retirement or provide yourself with a regular stream of income in retirement.
When it comes to making sure you are financially prepared for retirement, annuities can be very powerful vehicles. They provide the means to accumulate funds on a tax-deferred basis, which can make a significant difference in your ability to achieve the lifestyle you envision for yourself throughout this potentially very active stage of life.
Annuities are sometimes thought of as being the opposite of life insurance, in that you buy life insurance to pay a benefit in the form of policy proceeds to your beneficiary when you die, and you buy an annuity to pay a benefit in the form of a stream of income to yourself while you are alive.
In exchange for either a single deposit or a series of deposits you make into your annuity, the insurance company promises to make a series of payments to you out of the annuity — payments you can use to supplement your income after you retire.
The guarantees in an annuity are backed solely by the claims-paying ability of the insurance company, and should be a key consideration in making your purchase decision.
- Deferral phase: Annuities have a deferral phase and an income phase. The deferral phase refers to the time period between the date the contract is established and the date of the first distribution. During this time, values accumulate on a tax-deferred basis, at either a fixed or a variable rate of return. If you have an immediate annuity, the deferral phase is either non-existent or very minimal, in that the first distribution from the plan typically takes place within one year. If you have a deferred annuity, the deferral phase will continue until the income begins at some future date.
- Income phase: Whether immediate or deferred, the income phase refers to the time period that income is withdrawn from the annuity, which may be for a specified number of years or for a lifetime.
Annuities are not "one size fits all" products. However, whether you are just starting to plan for retirement, are fast approaching retirement, or have already retired, an annuity may be right for you. Take the following points into consideration in determining if an annuity is right for you:
- Annuities can work to your advantage if you will not need to take distributions from the plan until after you reach the age of 59½. The IRS imposes a 10% early withdrawal penalty for distributions prior to 59½.
- Annuity contracts may impose a withdrawal (surrender) charge for early withdrawals made during the early years of the investment.
- The earnings from annuities are not subject to income tax until they are withdrawn. Your principal earns interest, and your earnings compound on a tax-deferred basis. This can be especially appealing if you are currently in a higher tax bracket than you expect to be in after you retire.
- For non-tax-qualified contributions, there is no ceiling; you can contribute as much as you like.
- For non-tax-qualified annuities the IRS does not impose mandatory distributions; you may delay taking distributions from an annuity well into your retirement years.
- Avoids probate – Annuities do not need to go through the probate process for your beneficiaries to receive the death benefit.
Are you concerned about maintaining your lifestyle during retirement or the possibility of outliving your income?
Accumulating funds in an annuity during your working years can minimize gaps in income throughout your retirement years. Both income and deferred annuities offer a variety of income options, including those that can supplement your income during your early active years of retirement, help you sustain the lifestyle to which you have become accustomed, or guarantee a continuing income as long as you are alive, no matter how long that may be.*
If you have an employer-sponsored (tax-qualified) retirement plan, such as a 401(k), have you contributed the maximum amount?
If you have maxed out contributions to your employer plan and personal IRA, and want to save more for retirement on a tax-deferred basis, annuities allow continued contributions and tax-deferred growth. There is no IRS limit on the amount you can put into a non tax-qualified annuity.
Will you need the money before you reach age 59½?
Annuities are designed to be retirement vehicles. Therefore, if you take out your funds before age 59½ the IRS may subject you to a 10% early withdrawal penalty in addition to any applicable ordinary income tax. Contractual withdrawal charges may also apply.
Do you expect to be in a lower tax bracket after you retire?
When you are older you are likely to be in a lower tax bracket, which makes deferring taxes until you actually withdraw the funds all the more advantageous.
*The guarantees in an annuity are backed solely by the claims-paying ability of the issuing company.