You have worked hard to save for your retirement years but there are so many factors you can’t control, such as the rising cost of living, the fluctuating stock market, and low interest rates. If you are concerned about running out of money in your retirement years, you are not alone. Nearly one in two older adults fear not having enough money saved for retirement.
Annuities are a long established investment tool that can alleviate these concerns by providing lifetime retirement income. There are several types of annuities and consumers often find it difficult to understand the differences. Here’s what you need to know if you are considering an annuity.
What is an Annuity?
An annuity is a financial investment product offered by an insurance company. Annuities can be customized to your individual needs based on your risk tolerance and your financial goals. When you purchase an annuity, you sign a contract with the insurance company. This contract defines the specific terms of the agreement and outlines the obligations of the insurer and the policy owner.
There are several main types of annuities:
- Fixed Annuity – pays a guaranteed minimum income based on a fixed rate of return regardless of how the market performs. This annuity offers predictability, but rates of return can be modest and may not keep up with inflation.
- Variable Annuity – there is no guaranteed fixed interest rate, and your income payments will depend on market performance. You have the opportunity for greater returns but also risk losses if your investments perform poorly.
- Indexed Annuity – offers a balance between risk and predictability. The interest rate earned is tied to a stock market index such as the S&P 500 and provides a guaranteed minimum rate of return while also protecting against loss within a fixed range.
Death Benefits and Riders
Depending on the type of annuity you purchase, you may be able to designate a beneficiary who can receive a death benefit after you die. The benefit can be the remaining value of the annuity, or a minimum amount specified in the contract. Payments can be made in a lump sum, or installments paid out over time. Not all annuities automatically include a death benefit
Many annuities can also be customized through additional riders for an additional cost. Common riders include:
- Lifetime Income Rider – the insurance company will continue to make your income payment even if your annuity runs out of money.
- Cost of Living Rider – ensures your annuity payments keep up with inflation over time.
- Impaired Risk – if you become seriously ill and have a lowered life expectancy, your annuity will increase payments, so you get more money sooner.
- Death Benefit Rider – if you die and have received less in payments than you paid into your annuity, your beneficiary will receive at least as much as you paid into the annuity. This is also known as a “return of premium” rider.
Payment Options
There are two types of annuity contracts, immediate and deferred. Each type comes with its own schedule for income payments.
- Immediate Annuity – also known as a single payment immediate annuity, is usually funded with a lump sum payment and provides income payments over a set period of time. Income payments can begin almost immediately after you purchase the annuity.
- Deferred Annuity – income payments are delayed for at least a year or longer in order to give your money time to grow. These annuities can be purchased with a lump sum payment or funded over time through periodic payments. Income payments from deferred annuities can be received in the frequency you choose such as a lump sum or annually, semi-annually or monthly.
Tax Benefits
Annuities offer taxed deferred growth potential for the length of your contract. This means you don’t pay taxes until you start receiving payments. If you withdraw money before the age of 59 ½ you may have to pay a 10% tax penalty on the earnings portion of your withdrawal, similar to an early withdrawal from a 401K. If your qualified annuity is funded by pre- tax dollars your distributions should be taxed as ordinary income.
Understanding Fees and Penalties
Commissions and fees can vary widely between policies and insurers. A commission is charged at the time of purchase and administrative fees can be charged for the life of the contract. It’s important to understand what fees are associated with an annuity and how they would reduce your future payments.
Annuities are meant to be long term investments. If you take money out before the end of the surrender period specified in your contract, you will be subject to an early withdrawal penalty. Before purchasing an annuity, you should make sure you have enough liquid assets on hand so that you don’t need to access these funds before the end of the surrender period.
A Financial Professional Can Help
Finding the right investment strategy for your retirement can be difficult to do on your own. Which annuity is right for you depends on your individual needs, your risk tolerance and retirement goals. A licensed financial planner at Healthcare Educators can offer the guidance you need to make informed decisions and pave the way to a more secure financial future. Contact us today.