You spend your entire adult life saving for retirement, amassing a small fortune along the way. Then, as you approach retirement the challenge switches from saving enough to ensuring that what you’ve saved lasts. More than six in 10 people in a recent survey say that having enough money to last their lifetime is their most important financial objective.
One of the key ways to make sure your income lasts through retirement is to add an annuity to your financial plan. There are many different types of annuities, but at their core an annuity is designed to create regular, predictable payments for you in retirement — in many cases the payments continue as long as you live.
Now that you’ve got the basics, here are the different types of annuities you can buy.
ANNUITIES THAT PROVIDE INCOME
Immediate income annuities are the most traditional and the easiest to understand. You pay an insurance company a lump sum up front. Then at some point in the future, typically within about a month (but no later than 13 months), you begin receiving a pre-determined amount of monthly income (say, $1,000 a month) that continues for the rest of your life. You can also specify that you want payments to last for a certain period of time, say 20 years, even if you die before then. In most cases, the income payments will not increase over time. However, there are ways to build income annuities with payments that will increase.
Consider an immediate annuity to turn a portion of your savings into a reliable income stream that will last for as long as you want, and won’t be subject to market ups and downs.
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Deferred income annuities are a close cousin to immediate annuities, however deferred income annuities don’t start making income payments right away. Instead, the insurance company promises to pay you a pre-determined amount of income beginning at a set time in the future (say, 10 or 20 years from now or when you turn age 80) that continues for a period of time or the rest of your life. Like immediate income annuities, these involve paying an insurance company a lump sum (or sometimes a series of payments over time). However, since income payments start further into the future, unlike immediate income annuities, there is an accumulation period where the insurance company invests your premium contributions and promises a higher income in the future as a result. Some companies also offer an option to earn dividends, which has the potential to increase the income you will get in the future even more.
A deferred income annuity may make sense if you want to add certainty to your retirement planning. For instance, if you have recently had investment gains and want to use some of those gains to guarantee a certain level of annuity payments in the future, a deferred income annuity may make sense.
ANNUITIES THAT ACCUMULATE VALUE OVER TIME
Unlike income focused annuities, accumulation annuities give you the option in the future to withdraw your account value1 or convert to an income stream and get guaranteed payments over time.
Deferred fixed annuities are kind of like a CD that you get at a bank. While your money must be locked away for set period of time (there are typically fees for early withdrawal or surrender), you know exactly how much interest you will earn. Fixed annuities provide the opportunity for money to grow, tax-deferred, at a guaranteed rate of return for a fixed amount of time without risk of loss from investing directly in the market. At the end of each guarantee period, the guarantee typically resets for another specified period. At that time, you’ll have the ability to continue the annuity; exchange it for a different type of annuity; or cash it in and invest the funds elsewhere. If you opt to cash in the annuity, you’ll owe ordinary taxes on the accumulated tax-deferred interest and a potential penalty if done before age 59 ½. These types of annuities can also offer additional protections like a death benefit. Consider a fixed annuity if you think you’re interested in an income stream from an annuity in the future, but want to grow your assets at a predictable rate between now and then.
Deferred variable annuities work differently than fixed annuity, where your contract value grows at a guaranteed rate of return. A variable annuity’s returns vary depending upon the performance of investment funds (sub-accounts) that you choose. While variable annuities don’t offer the principal protection of fixed annuities, many offer protections such as a death benefit guarantee. The death benefit guarantee ensures your beneficiary will receive the higher of your then-current contract value or the full amount you paid in (minus any withdrawals) should you die before starting to take payments from your contract.
A variable annuity2 may be a good option to save for retirement, especially if you will have a need for guaranteed income in the future or have maxed out of your workplace retirement plan and IRA contributions and are looking for an additional tax-deferred option to set aside funds for the future.
1 Withdrawals are pursuant to possible contract limitations/adjustments and IRS tax rules.
2 All investments carry some level of risk, including potential loss of principal. Withdrawals from variable annuities may be subject to ordinary income tax, a 10% IRS penalty if taken before age 59 ½, and contractual withdrawal charges.
Annuities are contracts sold by life insurance companies and are considered long-term investments that may be suitable for retirement.
All guarantees associated with annuities and income plans are backed solely by the claims-paying ability of the issuer.