Use the contractual guarantees of annuities to build your retirement income.
Every decade people are living longer. From 1960 to 2019, the average life expectancy of Americans rose from 70 years to 79 years, while the retirement age increased slightly to 67 years of age in 1983. Because of this gap between retirement and life expectancy, retirees must manage their wealth, accounting for the possibility of outliving their money. Of course, most retirees are not millionaires, and their years of earning paychecks are far behind them. But it’s not the size of the fund that matters so much; it’s how you plan to use it. Annuities are popular financial products that can help individuals’ retirement savings go the distance.
One retirement savings vehicle in any retirement planning toolkit is the fixed annuity. Fixed annuities are sold by insurance companies and provide a long-term investment option that pays out a monthly income depending on the principal and amount of time before the first withdrawal. Retirees can purchase fixed annuities with a single lump sum or a series of smaller payments. In exchange, the insurer guarantees a minimum interest rate on the deposit. The guaranteed minimum interest rate is typically between 1 and 2 percent, while the best-fixed annuities can have rates above 2 percent.
Annuities fall into two categories, immediate and deferred. An immediate fixed annuity will begin paying out within a year of signing the contract. A deferred annuity will start paying out sometime in the future; this can be as soon as a few years or as long as 20 years. Each product is specialized to provide various benefits specific to investors’ goals.
Immediate Annuities
Immediate annuities work by converting a large amount of cash into an income stream. Investors make a single payment, an annuity option is selected, and the distribution begins within 12 months after the purchase. Each distribution is both a return on the original investment and earnings. The only taxed part of the distribution is the earnings portion. This type of annuity would be most attractive to those investors looking to avoid outliving their investment.
Deferred Annuities
Deferred Annuities are not unlike immediate annuities because both convert investors’ money into an income stream. Investors 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.
Immediate annuities and deferred annuities both allow for unlimited contributions and provide a continuous income stream for life. The two terms indicate when the distribution phase will begin. Either way, fixed annuities provide investors with the means to be fiscally responsible and play an essential role in developing a safe and sound retirement plan.
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