In planning and preparing for retirement, you can consider many investments. Annuities are one type of investment that is growing in popularity.
Annuity products allow you to invest a lump sum and receive a steady income stream. This article will discuss investment options available through annuities.
What Are Annuities?
An annuity is an investment account issued by an insurance company that allows a person to have a guaranteed income as part of a strategy to build future income.
When you enter into an annuity contract, you set money aside. The balance experiences tax-deferred growth yearly without tax liability to the annuitant (investor).
When you own an annuity, you get a stream of future payouts on a timetable you control. You can use an annuity to reach your financial goals and improve your financial strength.
In exchange for your lump-sum payment, the insurance company agrees to give you benefits, including:
- An income for a set period of time or life
- Accumulation and asset growth
- A death benefit
- Retirement income
- Long-term care benefits
Unlike IRAs, there is no limit on how much money you can place in an annuity. But, once you begin receiving annuity payments, your payments are taxed as ordinary income.
Annuities are sometimes included in a personal injury settlement or civil lawsuit. With structured settlements, the defendant's insurance company funds an annuity for an injured plaintiff. Settlements structured this way may have different investment objectives and risks than annuities bought to supplement retirement income.
How Annuities Work
By investing in an annuity, you'll get a payment at a future date or a series of dates. You can get monthly, quarterly, annual, or lump sum annuity income.
You invest premiums in different accounts. They are usually mutual funds, but more conservative options are available. You can control where your premiums get invested and the rate of return on the annuity.
Annuities differ from other types of retirement vehicles in several ways. For example, annuities have higher fees and expenses than other types of investments. This is due to the insurance component of annuities.
Insurance providers and financial professionals who sell annuities make money off these fees. Also, if you die before getting all your annuity payments, the insurance company will keep the remaining amount in your fund after settling your obligations.
Types of Annuities
Annuities can be either immediate or deferred. Immediate annuities begin paying income right away. This means they begin paying after less than one year. In contrast, deferred annuities start paying at a future time, typically between one and 50 years from the date of purchase. Annuities can also be fixed or variable.
Fixed annuities will provide you with a definite number and amount of payments under the conditions determined when you bought the annuity.
The principal value of a variable annuity depends on the performance of the sub-account values to which your money gets allocated. Variable annuities allow you to take part in the stock market. You'll still enjoy annuities' tax-deferred, insurance, and lifetime income benefits. For this reason, variable annuities are sometimes called "mutual funds with an insurance wrapper." You have some control over the investment risk because the interest rate is based on a portfolio of securities chosen by the annuity owner.
An indexed annuity pays an interest rate based on a specified market index's performance. For example, an indexed annuity may be tied to the performance of the S&P 500. When the financial markets perform well, you can earn higher yields than fixed annuities.
Fixed annuities pay a fixed interest rate regardless of market performance. The year-over-year gain in the index or its average gain over 12 months determines the interest rate.
Withdrawals from an Annuity
Many people intend annuities as a long-term part of a retirement income plan. As such, the insurance companies selling annuities and the government discourage early or frequent withdrawals.
Insurance companies can enforce surrender charges. These are penalties for withdrawals taken before the surrender period ends. Surrender fees discourage annuity owners from using this insurance product as a short-term investment for quick cash.
Required Minimum Distributions
In general, annuities are not subject to required minimum distributions. But, there's an exception for holding an annuity in a qualified retirement account such as an IRA.
Qualified variable annuities in IRAs are subject to the IRS's required minimum distribution rule. The IRS requires owners to withdraw once they reach 73 or face a 25% penalty. The annuity owner can reduce the penalty if they correct the issue.
Speak With an Attorney About Annuities
Deciding on what sort of retirement planning and investment strategy is best for you is complex. There are many factors to consider. Speak with a financial planner. Consider talking with an insurance law attorney if you have legal questions about annuities.
You Don’t Have To Solve This on Your Own – Get a Lawyer’s Help
Meeting with a lawyer can help you understand your options and how to best protect your rights. Visit our attorney directory to find a lawyer near you who can help.