Annuities can sometimes be beneficial financial products, in the right circumstances. With a clear understanding of what annuities are and how they work, you can better determine whether or not an annuity could help you meet some of your financial goals.
An annuity is a type of insurance contract into which you invest money today in order to receive payments on a future date or dates. These payments are made either in a lump sum or on a monthly, quarterly or annual basis. The money you invest in an annuity grows on a tax-deferred basis, with earnings (but not contributions) taxed at ordinary income tax rates upon
A Permanent Stream of Income
Annuities can be especially useful as a tool for creating a consistent stream of steady income for you and your spouse later in life, such as during retirement. There are no annual contribution limits with annuities, like there are with qualified retirement plans. Therefore, annuities may be an especially attractive option if you’re nearing retirement age and want to save as much money as possible before you retire.
There are two main types of annuities: deferred annuities and immediate annuities. With a deferred annuity, the money is invested now but typically not withdrawn until a date in the future, such as during retirement. At this time, the money can be withdrawn in a lump sum, over a period of years or for the rest of your life.
With an immediate annuity, you receive payments soon or immediately after you make your initial investment. Immediate annuities are often used by individuals who have recently retired in order to lock in an income stream for a set number of years or for life.
Within these two main types of annuities are two more categories: fixed annuities and variable annuities. As the name implies, a fixed annuity pays out a fixed sum of money on a future date or dates. It’s similar to a Certificate of Deposit (CD) in that you know exactly how much money you will receive and when.
With a variable annuity, you invest in a selection of sub-accounts (which are similar to mutual funds) that are offered within the annuity. The value of the annuity at a later date — and, hence, the income you will receive — will depend on the performance of the sub-accounts you chose.
So Which Type is Best?
To determine which type of annuity might be best for you, start by answering a few questions:
- How close are you to retirement? If you’re close to the age at which you’d like to retire or are already in retirement, a fixed immediate annuity might be worth considering. This is because there aren’t many years left during which you can take advantage of the tax-deferred growth potential of a variable annuity.
- How much risk are you comfortable assuming? If you’re risk-averse, you may want to choose a fixed annuity (either deferred or immediate) and thus avoid the uncertainty inherent in variable annuities. But if you’re willing to assume some investment risk — and if you’re relatively young and have a number of years left until you plan to retire — you may be able to achieve long-term capital appreciation by choosing a variable annuity.
- How important is it that you lock in a fixed payout amount? If you want to ensure a fixed payment amount and a guaranteed income stream for a certain number of years or for life, a fixed annuity (either deferred or immediate) may be your best choice.
How We Can Help
With the different types of annuities available and all the different variations on these types, choosing the right annuity for your situation can be challenging. Please contact us if you have more questions about annuities and whether or not purchasing an annuity is a wise financial decision for you.