You spend your entire adult life saving for retirement, amassing a small fortune along the way. Now, as you approach retirement, the challenge switches from saving enough to ensuring that what you’ve saved lasts.
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 types of annuities, but at their core, annuities can help you save for retirement, and/or create regular, predictable income payments for you in retirement — in many cases, payments that continue as long as you live.
What is an annuity?
An annuity is an insurance and a financial product. Annuities are used primarily to guarantee an income in retirement. While there are many different types of annuities and they can often be complex, annuities can help you plan for retirement.
What are the different types of annuities?
Now that you’ve got the basics, here are the different types of annuities you can buy.
What types of annuities are accumulation annuities?
Accumulation annuities allow you to build a nest egg over time. Then, in the future, you will have the option to withdraw your account value1 or convert to an income stream and get guaranteed payments over time.
Fixed annuities are a little bit like a CD that you get at a bank but they are not FDIC insured. With a CD, your money must be locked away for set period of time (there are typically fees for early withdrawal or surrender); the tradeoff is that 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. While you can take your money elsewhere in the future, you may owe penalties and taxes depending on when you withdraw it. 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.
Variable annuities work differently than fixed annuities, 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 current contract value or the full amount you paid in (minus any withdrawals) should you pass away while your money is in the annuity.
If you are comfortable with market risk, 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 if you are looking for an additional tax-deferred option to set aside funds for retirement.
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What types of annuities are income annuities?
Immediate income annuities
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 many 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 select and won’t be subject to market ups and downs.
Deferred income annuities
Deferred income annuities are a close cousin to immediate annuities, but they are different in that 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, this gap in time is called the deferral period. Once the deferral period has passed, the payments begin and will continue 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, the benefit of the growth during the deferral period is that future income payments will be higher than what you would get by spending the same amount to buy an immediate income annuity when you retire. Some companies also offer an option to earn dividends, which has the potential to further increase the income you will get in the future.
A deferred income annuity may make sense if you want to add certainty to your retirement planning in the years leading up to retirement. 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, likely at the start of your retirement, a deferred income annuity may make sense.
What type of annuity fits your financial plan?
Annuities can be a great way to guarantee income in retirement. Wondering what type of annuity fits into your financial plan? Get in touch with an advisor.
1Withdrawals are pursuant to possible contract limitations/adjustments and IRS tax rules.
2All 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. Income annuities (either immediate or deferred) have no cash value and once issued they can’t be terminated (surrendered). The original premium paid is not refundable and cannot be withdrawn.
All guarantees associated with annuities and income plans are backed solely by the claims-paying ability of the issuer.