Annuities offer a great way to plan for the future because they provide the promise of regular, monthly money that can supplement Social Security and pension income. When someone buys an annuity contract from an insurance company, the income earned inside that annuity grows and can be on a tax-deferred basis until it is withdrawn. Annuities work out 90% of the time, but the other 10% of the time there are unforeseen occurrences and life gets in the way. Sometimes you need finances urgently instead of waiting for a check every month.
Annuities can be structured as immediate or deferred annuities. With an immediate annuity, the money that is deposited into the annuity contract is turned into an income stream right away. The period while you are collecting funds inside the agreement is known as the accumulation phase. First, if you want to withdraw money from a qualified annuity before you reach the age of 59 ½, you can expect to pay the penalty. You may also have to pay a surrender charge.
Fixed Annuities Offer You a Financial Safety Net
Another type of annuity contract is a fixed annuity. As its name implies, a fixed annuity offers a fixed rate of interest for contributed assets. In most cases, there is a guaranteed minimum interest rate. One of the most popular features of fixed annuities is that they come with a guarantee that the annuity owner will not lose their money (assuming the insurance company behind the contract stays in business).
Distribution Options for Your Annuity Payments
Some insurance companies do not let you withdraw funds out of your annuity. Instead, the payments must be paid out on a monthly basis per the contract.
Many people choose to take a guaranteed monthly income stream for life. If you are married, it is also possible to take a guaranteed income stream for your life and your spouse’s lifetime. When you choose one of these options, the insurance company is assuming the risk that you may live for years after the original annuity contribution and earnings have been distributed. When an annuity is still in the accumulation phase, you can either take lump-sum distributions or schedule periodic distributions. However, when the money inside the contract has been paid, the annuity will end.
What to Expect from Life-Contingent Annuities
In some cases, life annuities can also provide benefits for a spouse’s lifetime after the annuitant dies. A life-contingent annuity contract can be a great deal – or a not-so-great deal. The amount of each monthly or annual payment is based on your life expectancy. For example, if you die unexpectedly two years into receiving payments, the annuity just stops. However, if you live ten years longer than your life expectancy, you are earning ten free years of extra payments.
Annuities are described as “reverse life insurance” contracts. Life insurance is a contract between the insurance company based on the life of an insured person. A benefit becomes payable when a person dies, thus protecting against the risk of dying too soon and not having enough money to care for those left behind.
An annuity operates in reverse. The contract, between the insurance company and the annuity owner, based on the life of the annuitant . The risk being protected by an annuity is that of living too long and outlasting your financial resources to maintain and continue in a comfortable lifestyle.
How Annuities are Used
Charitable Gift Annuities – A type of annuity used in estate planning. It permits the owner to direct payments to a designated charitable organization as beneficiary and provide immediate and future tax benefits to the annuity owner.
Retirement Annuities – A type of annuity funded with a single payment or a series of payments over a period, up to the annuity payout, at which point payments cease, and a stream of income is paid for a predetermined time.
Structured Settlement Annuities – A type of annuity that is used to structure the payment of a significant, lump-sum amount, over time, such as a legal settlement or lottery winnings.
Equity-Indexed Annuities - A type of fixed annuity that is often confused with variable annuities is the equity-indexed annuity or EIA contract. EIAs credit interest rate based on the performance of an underlying index, such as the S&P 500. Contract holders often, however, do not earn the full amount of returns of the underlying index.
This is because as a fixed annuity, the insurance company takes on the performance risk and must pay some return up to include no return while absorbing any negative returns of the underlying index. Individuals buying EIAs do so with an understanding that some or all of the underlying performance of their chosen annuity index may not be credited as a tradeoff for the guarantee of no negative returns. Negative returns may, however, subject you to inflation risk, that is the risk that the overall performance of your annuity may be well below the prevailing rate of inflation and thus, in fact, lose money to time.
Understanding How Annuities Work
Ideally, a person who is looking to supplement or enhance their income in retirement and who has exhausted all available avenues for saving, such as an employer-sponsored retirement plan or individual retirement account. Annuities provide an excellent way to ensure a stream of income for retirement and protect against the risk of living too long; it is essential that you ask questions about how an annuity being proposed works and if such product is appropriate for your situation. There is no one size fits all solution when it comes to the use of annuities but careful planning and diligence on your part, including requesting and reading all disclosure material and buyer’s guides, can go a long way in protecting your interests and making you a savvy annuity buyer.
