What is an Annuity?
Annuities can provide a guaranteed income stream that you can use in retirement. They can add stability and security to your plan and are sometimes considered a safer alternative to other types of retirement accounts. This is because you don’t have to wonder how much you will receive from each payment, but there are many more things to consider to determine if an annuity is right for your plan.
Put simply, an annuity* is a fixed amount of money that you are paid out over time – typically as part of a diverse retirement plan. Annuities work much like social security, except the transactions occur through private insurance companies rather than the federal government. Guarantees are backed by the claims-paying ability of the insurer. This means that choosing a reputable, financially strong company to work with is especially important.
Funding an annuity
You start with “funding” an annuity by either contributing one lump sum or multiple payments over time. There is no limit to how much you can put into this account. An annuity can be right for you if you have a sum of money that you don’t need right away, want to defer taxes on the income, or need a flexible option for receiving payments over time. Your annuity can provide a guaranteed return. All investing involves some risk including possible loss of principal.
What is a variable vs. fixed annuity?
A fixed annuity is an insurance product rather than an investment because the amount you receive is “fixed” or guaranteed by an insurance company. It can provide a predictable and stable income stream during retirement. A fixed annuity requires no work from you to manage or adjust over time because the insurer provides a set amount of return and the value can never decrease. This fixed interest is based on several factors including the amount in your annuity, current economic climate, type of contract purchase, etc. and is not taxed until you begin to receive payments.
Variable annuities are different because you are investing in a product that has the potential to provide higher returns based on the performance of a specific portfolio of sub-accounts that may include stocks, bonds and money market accounts. However, with this potential for gain, there is also a certain amount of risk involved. There are no guaranteed returns with variable annuities. As with fixed annuities, you won’t pay taxes on any gains until you start receiving payments, and this income will be taxed at your ordinary income tax rate.
Receiving annuity payments
When you fund an annuity, you can choose for it to be immediate or deferred. Immediate income annuities allow you to start receiving payments right away – typically within 30 days based on your age. This can be a good idea if you are already retired and want to enjoy the benefits of your annuity now. Deferred annuities start paying you at a future date which can be anytime within 1-50 years depending on the plan you choose. It’s your decision when to begin receiving your annuity payments, but usually is based on how much is in the fund, the size of your payments and how long you’d like them to continue. There are even plans that provide payments to an heir in the event of a death.
Annuities can be flexible in terms and options, so you will need to research your choices to determine which one is right for you. This is not a plan that you purchase on your own, but would benefit from a discussion with a knowledgeable advisor to find the right plan for your needs.
*Annuities are long-term investments designed for retirement purposes. Distributions are subject to income tax, and if taken before age 59½, a 10 percent federal tax penalty may apply. The annuity may be subject to lengthy surrender periods and early withdrawals subject to surrender charges.
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