What Is an Annuity and Could It Be an Option For Me?
Whether you’re planning for retirement or simply want to grow your wealth, there are many alternatives to consider.
Recent years have seen annuities growing in popularity with investors. In fact, fixed annuities alone racked up a record $117.4 billion in sales in 2016, up 14% from 2015.1
But what, exactly, is an annuity? How do annuities work? And do annuities make sense for your financial goals?
Since June is National Annuity Awareness Month, we thought this would be the perfect time to provide you with some helpful information about this financial option.2
For starters, an annuity is a long-term contract with an insurance company that is intended to provide a guaranteed income stream when you retire.3
- It lets you set aside a large amount of money while deferring tax payment.
- There is no annual contribution limit.
- When it’s time to withdraw funds, you can take a lump sum or set up regular payments on a monthly, quarterly, or annual basis.
- Upon withdrawal, accrued earnings, but not your principal, will be treated as taxable income.
- Withdrawal before age 59 ½ requires a 10% early withdrawal tax plus regular income tax on interest-earning portion.
- Some types of annuities may include a death benefit for your beneficiaries.4
What Are the Different Types of Annuities?
There are two primary ways to categorize annuities:
- Fixed or variable
- Immediate or deferred
Fixed vs. Variable Annuities
With fixed annuities, you receive a fixed rate of interest for a predetermined period of time. Both your rate of return and payout are guaranteed.5
- This may be a product for conservative individuals who like predictability.
- Your Insurance contract grows tax-deferred.
- Payments may last for a specified time period, such as 25 years, or an unspecified time such as the remainder of your lifetime.
- There are no cost-of-living adjustments to help you keep pace with inflation.
- Fixed annuities are regulated by state insurance commissioners.6
With variable annuities, you customize a mix of stocks, bonds and/or mutual funds consistent with your investment goals and risk tolerance.7
- Your earnings depend on the performance of the investments over time.
- You may withdraw your earnings as a lump sum or in a series of monthly, quarterly, or annual payments.
- You must pay surrender charges if you elect to withdraw money early.
- You may incur higher annual fees.
- Variable annuities are regulated by Securities and Exchange Commission.8
Immediate vs. Deferred Annuities
With immediate annuities, you start with a large sum of money and begin receiving regular payments one period after your initial purchase.
- Immediate annuities are typically favored by individuals between the ages of 55 and 80.
- You accumulate money on a tax-deferred basis only during the early payout years.
- Only the portion of income derived from contract earnings is taxed.
- Payments end after you pass away. Payments may continue to beneficiaries after your death if the annuity has a guaranteed period that hasn’t expired.
Deferred annuities accumulate value over a period of several years, with payments beginning at a later time determined by the individual.
- Deferred annuities are often purchased between the ages of 40 and 65.
- Earnings are accumulated on a tax-deferred basis.
- Only the portion of benefits derived from interest income is taxed.
- Your beneficiaries receive a death benefit.9
Annuities come with additional options that you may want to discuss with your financial professional.
- Indexed annuities. Sometimes called equity indexed annuities, this is a more complex product that combines features of fixed and variable annuities. You receive a guaranteed minimum interest rate along with a second interest rate that is tied to a market index, such as the S&P 500 Composite Stock Price Index.10 At The Resource Center, we recommend a Fixed Indexed Annuity for some situations, combining multiple aspects to pursue the customers’ goals.
- Qualified vs. non-qualified annuities. With a qualified annuity, you put money into a tax-favored plan such as an IRA or 401(k). A non-qualified annuity is purchased separately from a tax-favored retirement plan.
- Single-premium vs. flexible premium annuities. As the name implies, a single-premium annuity is funded by a single payment. Flexible premium annuities are funded by a series of payments over time.11
- Guaranteed benefits. If you choose an annuity with a guaranteed death benefit, your beneficiary will receive payments if you pass away before the withdrawal date. With a guaranteed minimum income benefit, you receive a minimum ongoing payment regardless of market fluctuations.
What Are the Advantages of Annuities?
As with all financial products, annuities may be a more optimal choice for some individuals than for others.
Here are a few of the potential advantages that annuities may offer:
- Guaranteed income stream. Especially if you choose a fixed annuity, you receive predictable payments that are somewhat protected from market fluctuations.
- Tax deferment. While your earnings are taxed at the current income tax rate upon withdrawal, your principal is not taxed.
- Income outlives you. Annuities can be structured to provide a steady stream of income for a set period of time or for the remainder of your life.
- No contribution limits. Unlike other retirement accounts such as 401(k)s and IRAs, you may put in as much money as you wish.
What Are the Disadvantages of Annuities?
Before purchasing an annuity, here are a few possible drawbacks you’ll want to be aware of:
- Fees. Annuities often carry fees or other charges, so be sure and read the fine print before committing. Agent fees or commissions are paid by the insurance company, unlike brokerage accounts where the client pays a fee directly to the agent . However, there can be extra fees for optional riders. These options might cover benefits such as higher income percentage, or access if you become disabled or move to a care facility.
- Early withdrawal penalties. Withdrawal before age 59 ½ may incur a 10% income tax penalty, on top of income taxes on earnings.
- Giving up access to savings. If you need access to your money before withdrawals are allowed, annuities may not be the best option for you.
- Complexity. As we’ve pointed out in this article, there are many different types of annuities. While this gives you the flexibility to choose the option that’s best for you, it may also make your decision more complicated. That’s why it’s important to talk with a trusted financial professional to go over all of your alternatives before making a final decision.
- Term variability. Annuities vary in terms, or the number of years that your balance would be insured for. If you need to withdraw more than the allowed amount you may pay a penalty.
Are annuities a good option for you?
Get in touch with us at The Resource Center. We will answer your questions about how annuities work and provide helpful information to help you make the best financial decisions for you and your loved ones.
1.LIMRA, Think Advisor, February 21, 2017, Fixed annuity sales hit record $117.4 billion in 2016, http://www.thinkadvisor.com/2017/02/21/fixed-annuity-sales-hit-record-1174-billion-in-201?slreturn=1498135343, Accessed June 20, 2017.
2. InSource, 2017, June is annuity awareness month, http://insourcemg.com/june/, Accessed June 20, 2017.
3. The Center for Annuity Awareness, 2017, What is an annuity?, https://www.annuityawareness.com/, Accessed June 20, 2017.
4. The Center for Annuity Awareness, 2017, Annuities and taxes: What you need to know, https://www.annuityawareness.com/annuity-resources/annuities-and-taxes-what-you-need-to-know, Accessed June 20, 2017.
5, 7. Conrad, J. Victor, PICPA, June 26, 2015, What are the pros and cons of an annuity? https://www.picpa.org/articles/ask-a-cpa/2015/06/26/what-are-the-pros-and-cons-of-an-annuity, Accessed June 20, 2017.
6. FINRA, 2017, Fixed annuities, http://www.finra.org/investors/fixed-annuities, Accessed June 2017.
8. FINRA, 2017, Variable annuities, http://www.finra.org/investors/variable-annuities, Accessed June 20, 2017.
9. Insurance Information Institute, 2017, The difference between annuities and life insurance, http://www.iii.org/article/the-difference-between-annuities-and-life-insurance, Accessed June 20, 2017.
10. FINRA, 2017, Indexed annuities, http://www.finra.org/investors/indexed-annuities, Accessed June 20, 2017.
11. Insurance Information Institute, 2017, What are the different types of annuities? http://www.iii.org/article/what-are-different-types-annuities, Accessed June 20, 2017.
12. MNCPA, September 14, 2015, Annuities — Basics, pros and cons, http://www.mncpa.org/money-management/articles/2015-9-15-annuities-basics-pros-and-cons.aspx, Accessed June 20, 2017.
We are not permitted to offer, and no statement contained herein shall constitute, tax or legal advice. Individuals are encouraged to consult with a qualified professional before making any decisions about their personal situation. We are able to provide you with information but not guidance or advice related to federal benefits. Our firm is not affiliated with the U.S. government or any governmental agency. Investment advisory services offered only by duly registered individuals through AE Wealth Management, LLC (AEWM). AEWM and The Resource Center, Inc. are not affiliated companies.
Investing involves risk, including the potential loss of principal. Any references to protection benefits, safety, or security generally refer to fixed insurance products, never securities or investment products. Insurance and annuity product guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company. AW06173128