Annuities are financial contracts provided by insurance institutions that can guarantee steady income in retirement. This makes them an essential part of financial planning for many retirees. By allowing individuals to convert lump sum amounts or series of payments into regular disbursements, annuities mimic the reliability of a pension. They are a great choice for those seeking financial stability post-retirement.
Confused by the many different types of annuities? You’re not alone! The world of annuities can be overwhelming but choosing the right one can make a big difference in your financial future. So, let’s break it down:
Securing Your Retirement: A Look at the Different Types of Annuities
Fixed Annuity: The No-Frills, Guaranteed Investment
Fixed annuities are a type of annuity investment option that is popular with conservative investors who prioritize stability over high returns.
Think of a fixed annuity like a certificate of deposit (CD), but instead of purchasing from a bank, you’re working with an insurance company. In this scenario, you invest a lump sum for a set period (1 to 8 years), and you get a guaranteed minimum rate of return. Some plans let you withdraw a bit (usually 10%) each year. Ultimately, you get your principal back along with the earned interest at the end of the contract time period.
Annuity interest rates can vary between states of residence and offerings from insurance companies. Interest rates are generally based on the US Treasury 10-year posted rate.
Unlike bank CDs, the tax liability on interest earned in a fixed annuity is deferred until the funds are touched or used. Additionally, fixed annuity contracts have no associated fees and any remaining funds will go to your beneficiaries if you pass away.
Variable Annuity: High Risk, Higher Possible Reward
A variable annuity is a security sold by licensed security salespeople accompanied by a prospectus. This option is perfect for investors who like a little—or a lot—of risk in their financial plans.
Buying a variable annuity is similar to investing in mutual funds, also known as sub-accounts. Your account value can go up or down depending on market conditions. However, some plans guarantee a death benefit, ensuring a set amount to your heirs even if the market falters.
Variable annuities do charge fees, including fees for the contract, fees for managing your money in the sub-accounts, and fees for any additional riders placed on your variable annuity. Make sure to ask for a complete list of expenses and fees before diving in.
Fixed Indexed Annuity: The Best of Both Worlds
For those who want to safeguard their funds but desire a greater and yet unknown return, fixed-indexed annuities (FIAs) might be the perfect fit. Created in 1995, these annuities offer returns tied to an outside source, generally a stock market index fund, but still protect your principal. Your annuity performance is tied to a percentage of returns enjoyed by the selected index fund. But if the index fund does not earn a positive return for the time period (usually 12 months), your account value is fully guaranteed.
Fixed-indexed annuities are fully guaranteed against any loss of principal (market risk) by the issuing insurance company. The only thing at risk is the yield, and the reason for that is simple: the actual yield responsibility is passed to a third party (S&P 500 stock market index for example), and your yield depends on how the outside source performs over a period of time.
Understanding Your Payout Options: Immediate vs. Deferred Annuities
Annuities are generally classified into two categories based on when the payout begins: immediate and deferred. Immediate annuities and deferred annuities both allow for unlimited contributions and provide a continuous income stream for life. The difference between them lies in when the distribution phase begins.
Immediate annuities begin disbursing payments soon after the investment is made, which is ideal for retirees needing instant income streams. They work by converting a large amount of cash into recurring income. You make a single payment and select payout terms, and the distribution begins within 12 months after the purchase. Each distribution comprises a return on the original investment and additional earnings.
Only the earnings portion of an immediate annuity payout is taxed. However, it’s important to ask about any associated fees. Some companies may charge a fee for the income option, but if the annuity is actually used for income, the fees are almost always removed.
For those still a few years away from retirement, deferred annuities allow the investment to grow tax-deferred during your accumulation phase before the income phase begins. It’s a way to ensure that a part of your retirement portfolio is dedicated to providing a stable income later.
You can purchase deferred annuities with a lump sum or a series of smaller payments and defer repayment until a future date. Known as the accumulation period, the earnings made during this phase remain untaxed until distribution. This is an attractive option for those looking to supplement IRAs and pension plans like 401(k) plans.
Even More Options: Annuity Sub-Types
Annuities can be broken down further into several sub-types, which offer different payout terms, fees, and investment structures.
- Fixed-period annuities, also known as fixed-term annuities, are set to pay at specific intervals for a defined duration, such as 10 years.
- Single-life annuities pay out at regular intervals until the death of the annuitant.
- Joint-and-survivor annuities also pay until the annuitant dies, but afterward, payments will continue going to the annuitant’s spouse until their death.
- Tax-sheltered annuities, also known as 403(b) plans, enable employees to place pre-tax funds into individual annuity accounts.
- Multi-year guaranteed annuities (MYGAs) are the most common fixed-term annuities and include features like required minimum distributions.
- Single-premium immediate annuities (SPIAs) are the most common type of immediate annuity and can be paid out monthly, quarterly, semi-annually, or annually.
- Qualified longevity annuity contracts (QLACs) are a kind of deferred annuity that is purchased using funds from a qualified retirement account, like a 401(k) or IRA.
- Inflation-adjusted annuities increase payments over time, helping maintain the income’s actual value in comparison to inflation.
Additional Annuity Features Through Riders
To enhance the basic functions of annuities, insurers offer optional riders that may be added to contracts.
- Guaranteed lifetime withdrawal benefits ensure a continuous income for life, even if the annuity’s principal is depleted.
- Death benefit riders provide a sum to beneficiaries after the annuitant’s death (also known as income riders).
- Cost of living adjustment riders adjust payouts annually based on inflation to help retirees maintain their purchasing power over time.
- Long-term care planning riders help cover long-term care expenses, addressing a major financial risk for older adults.
The Big Question: Which One is for You?
Like any financial product, annuities are not a one-size-fits-all solution. Each of these annuity types has its advantages and considerations. Immediate and fixed annuities provide security and guarantees. The annuity buyer has outsourced the management of their funds to an annuity provider in return for guarantees.
Working with a reputable financial advisor with a fiduciary duty (an obligation to put your best interests first) is crucial. They may assess your individual risk tolerance, financial goals, and overall situation to determine if a specific type of annuity would make sense within your comprehensive plan.
Get Started With Annuities
Annuities offer a combination of benefits, from income stability to tax advantages and adaptability, making them a compelling choice for many retirees. By providing a steady, reliable income and various customization options, annuities play a critical role in many retirement strategies by providing confidence and security.
Are you concerned about outliving your retirement savings? Let’s explore how annuities can provide financial security and peace of mind in your golden years. Fill out our quote form today to discuss a personalized retirement plan that aligns with your goals and ensures a comfortable and secure retirement.
