What is an Annuity? Some Basic Annuity Education
An annuity is a guaranteed income paid out over time (through premiums). An annuity can be a part of a total retirement strategy because assets grow tax-deferred, and interest is compounded. This can result in major tax advantages when receiving payouts because taxes will be paid only on the interest earned if paid with after-tax dollars.
While they are not life insurance policies, most are typically issued by life insurance companies. Premiums can be paid as lump payments or overtime in regular increments.
There are no limits on how much premiums can be put into annuities by the IRS.
If annuities seem like they are a good fit, determine which one might be most appropriate for your financial goals. While there is a large number to select from, there are only a handful of different types of annuities, including immediate or deferred payout; fixed or variable interest, and liquidity options.
Immediate or Deferred Payout
An immediate annuity provides payments for a set period. In exchange, you must put a comparatively large initial lump-sum investment. They’re called “immediate” annuities because you begin receiving annuity income payments almost immediately (or sometimes the wait can be for up to 12 months after you deposit your money). This can be perfect for those who need income from their annuity right away.
In a deferred annuity, the annuity-owner receives payments starting at some later date, often when retirementing.
Fixed or Variable Interest
Fixed annuities pay a fixed rate of interest for a set period of time, typically over one to ten years. After that point, the interest rate may change, depending on the insurance company’s financial experience during that time, but the interest rate will never be below zero.
Variable annuities enable you to invest in a selection of sub-accounts, such as securities portfolios, fixed interest accounts, and money market securities. These sub-accounts are tied to market performance, and often have a corresponding managed investment portfolio after which they are modeled. Variable annuities do have the potential to fall below the market and may lose some of the principal.
Liquidity options
Most annuities allow you to withdraw either your interest earnings or up to 15% per year without a penalty (although any withdrawal from an annuity may be subject to taxes and a 10% federal penalty if taken prior to 59 1/2 years of age).
I wonder what the returns for annuities are? I’ve been thinking about them for a few years, and I wonder if now is the time…
One thing that is confusing about annuities is how to swtich from one to another, and if fixed are good to buy now when interest rates seem to be n the rise. Or wait to see if rates by the Fed rise? I guess I need more research to figure this out…
Hi Elton,
Some good questions, and ones that many of recent clients are asking.
In short: it depends (naturally).
Are you years away from retirement? What kind of tax bracket are you in? Are there other expenses coming up such as a college? Are you in good health?
Knowing the answers to these and other questions helps point to a direction on which annuity option works best.