What is an annuity?
Many investors look closely at options like CDs, money market accounts, and annuities when considering a retirement income stream. Of the three, annuities often have an undeserved negative reputation. So, it’s time to put that rumor to rest and shine a positive light on annuities, what they are, and if they’re right for you.
Annuities in a nutshell
An annuity is a financial product that provides an individual with a fixed or variable income stream for a specified period (from 15 years up to a lifetime) in exchange for a lump sum payment or regular payments over time that grows tax-deferred.
Often used as part of a retirement income strategy, annuities are beneficial to providing a predictable income stream that can supplement Social Security, pensions, or other retirement savings.
Annuities come in different types, such as fixed, variable, and indexed. Each type of annuity has unique features and investment options, so it’s a matter of finding the right one that fits your needs.
With a fixed annuity, the insurer guarantees a specific interest rate for a specific time period. A fixed index annuity provides the opportunity to earn interest based on the performance of an index. With a variable annuity, the returns depend on the performance of the underlying investments.
There may be fees, such as surrender charges, administrative fees, and investment management fees, attached to some of the annuity products. You should carefully consider these before making your investment.
What an annuity is
Retirement is an exciting prospect—it’s your time to live without being bound to the tick-tock of a clock. However, a primary concern for those nearing retirement age is having enough money saved to support living without a regular paycheck.
Annuities are designed to guarantee a retirement income to annuitants and potentially their beneficiaries. They’re long-term investments that can be added to diversify an overall investment portfolio. Annuity products are purchased for a set amount of time, and the payout is also specific to the amount invested. Even if you aren’t planning on retiring anytime soon, purchasing an annuity can provide an added income stream.
How an annuity works
There are many types of annuities available to suit your needs. Whether you’re looking for a guaranteed lifetime income, tax-deferred investments, or building a nest egg, there’s a perfect annuity product to purchase.
At its core, annuities are simple. Annuities were designed byare investment products insurance companies created to help investors safely build wealth.
The inner workings of annuities can become more complicated. Essentially, annuitants invest their cash as a lump sum or through monthly payments for a certain period in exchange for a lump sum repayment or an income stream. And this all depends on the type of annuity chosen.
Once your chosen annuity is funded, it goes through an accumulation phase before payouts begin. The money invested during this period is tax-deferred. When the annuitization phase begins, the annuitant begins receiving payments, whether as a lump sum or monthly. That money is subject to taxes and fees.
Due to the complicated tax structure associated with annuities, speaking with a financial professional before purchasing them is crucial.
The bonus of tax-deferred annuities
Tax-deferred annuities offer several advantages, making them a great investment option for individuals looking to save for retirement. They allow individuals to invest pre-tax dollars into their retirement accounts, reducing their taxable income for the year and potentially lowering their tax bracket, resulting in less tax paid.
The investment earnings on tax-deferred annuities are subject to taxes once withdrawn from the account. This allows the account to grow faster than a taxable account since the gains are reinvested tax-free.
Pros and cons of annuities
When it comes to investing, annuities have minimal risk involved. However, as with any investment, there are pros and cons.
Pros:
Easy to customize due to a variety of options based on goals.
Guarantees an income payment, whether lump sum or monthly withdrawals.
Tax-deferred growth until payments start.
Provides peace of mind from a steady income stream.
Cons:
They can be complex if you’re not familiar with them.
There can be high amounts of fees involved, cutting into assets.
Your lump sum is tied up for the investment period, and early withdrawals can be subject to penalties and fees.
The up-front costs associated with annuities can be high.
It’s essential to have the help of a financial professional to guide you through the process, navigate the information, and get you invested in an annuity product right for you.
