When it comes to guaranteeing lifetime income, few tools are as handy as annuities. Given that the original long-term savings vehicle — the company-sponsored pension — is almost as extinct as the coelacanth, it’s become abundantly clear that your employer is no longer going to look out for your long-term financial interests. In today’s business culture, that burden’s been shifted to you. This makes implementing a long-term, income generating retirement vehicle to augment your Social Security benefits more crucial than ever, and this is often where annuities can make the difference between a comfortable retirement or a struggle.
The ultimate retirement safety net, annuities are designed to provide you with income every month for as long as you’re alive. You keep living, annuities keep paying.
Essentially a form of insurance, the concept behind annuities is fairly simple: Depending on your choice of annuity, you pay an annuity carrier a premium either in one lump sum or in installments before you retire. In return, after a predetermined period of time, the carrier guarantees to repay you in predetermined monthly installments until your death — no matter what. With most annuity policies, as long as you pay the premiums, the insurer will fund your retirement for the rest of your life. In most cases, when you die, whatever is left goes to your beneficiary.
While lifetime income is one of the annuity’s most appealing features, they offer additional benefits worthy of your consideration, not the least of which is favorable tax treatment. All of the money you use to fund an annuity grows tax-free until the point at which you begin withdrawing funds. As with most products, however, there are penalties associated with premature withdrawal, and those penalties extend to taxes in the form of treatment as ordinary income. That said, it’s always a good idea to discuss the tax benefits or limitations of annuity products with a professional advisor or agent to ensure you understand the policy thoroughly.
Another benefit of annuities is that when compared to other “safe money” choices such as bank CD’s, they tend to earn more interest. Some fixed index annuities have roll-up rates as high as 7% when you buy the optional rider.
Since annuities aren’t designed for short-term investment, the longer the annuity is funded, the better those returns are likely to get. Shop your annuity products carefully (or ask your advisor to do so on your behalf) to find the most appropriate product with the best rates of return. Here are some choices:
Fixed Annuities: The most conservative form of annuity, a fixed annuity earns interest at rates determined by the carrier or in a manner outlined in the contract.
Variable Annuities: Variable annuities have a strong investment component, as the insuring company invests your money into what are called sub-accounts they select based on your risk aversion profile. These are the riskiest annuities available, as those sub-accounts can be invested into stocks, bonds or other investment products. If those underlying investments fail, it is possible to lose a portion (or even all) of your money. That’s why I recommend most investors stay away from variable annuities.
Equity-Indexed Annuities: Equity-indexed annuities are fixed annuities for which the interest rate is tied to an investment index, such as the S&P 500. Considered to be somewhere in the middle of the risk spectrum, the base premium is guaranteed, but if the index performs well, you can earn higher returns.
Single-Premium Annuities: This type of annuity is funded wholly upfront with one single payment. These are often ideal for those looking to transfer funds into a better performing vehicle.
Multiple-Premium Annuities: Outstanding tools for those looking to accumulate savings, these annuities are funded by paying a predetermined amount of premiums to the insurer.
Deferred Annuities: Deferred annuities are structured in such a way that the payments from the insurer don’t commence for many years, commonly known as the accumulation phase – the time during which you actually fund the annuity – until the annuitization (or payout) phase, which typically occurs upon retirement.
Immediate Annuities: Unlike deferred annuities, an immediate annuity pays out very quickly, typically no later than a year after the purchase. Its name more or less says it all.
With so many annuity options in the market, engaging an advisor to help you navigate the maze of products might make sense. But if you do decide to go it alone, do as much research as you can, weigh your prospects carefully, and only buy an annuity from a company with a strong financial rating. Check out information sites such as: http://
And remember, while annuities can be the answer for the vast majority of Americans, they’re certainly not appropriate for everyone. Like all investments, some annuities are good, some are bad. Annuities work best for older investors looking for lifetime income, not younger investors growing their savings. Annuities have surrender charges for early withdrawal, and there can be tax penalties as well. And like many fixed-income investments, annuities are subject to interest rate risk. As with all investment options, do your homework and consult professionals.