Most people plan to retire from work, not life, so having an adequate savings and income to live the life you want to means taking advantage of all the options that are available to you.
An annuity is a contract between you and an insurance company in which you make one or more payments in exchange for a future income stream in retirement. There are many different types of annuities; however, the funds in an annuity accumulate tax deferred regardless of which type you select. This benefit alone has become an attractive way to accumulate money for retirement.
How do annuities work?
At the most basic level, annuities have two stages: the deferral stage and the conversion stage. The deferral stage is when you open an annuity with the insurance company and fund it either by a lump sum or periodic payments called premiums. The money then is left in the annuity to accumulate over time. At the conversion stage, the insurance company begins making payments back to you from the total accumulated value of your annuity. This stage is often sometimes called the annuitization or income stage.
Which annuity is right for you?
When considering which annuity is right for you, it really depends on your unique situation. There are five general categories of features that we will need to sit down and discuss further, but below are the general descriptions of each:
- Lump Sum – some annuities will allow you to fund the account up-front with one payment.
- Flexible Payments – the most common method of paying into your annuity is either on a fixed schedule or as you wish.
- Immediate – payouts start right away. This option is good for people who need an income stream immediately.
- Deferred – funds are able accumulate for years or decades. This is good for those whose retirement is further away.
- Type of Interest
- Fixed – guaranteed minimum interest rate that ensures you annuity won’t lost value while it grows. The percentage of growth also has the ability to be fixed.
- Indexed – the interest is based upon the performance of an equity index and can vary greatly.
- Variable – the return changes according to the underlying investment; meaning the value of your annuity can go up or down.
- Form of Payout
- Fixed Period – payments are made to you for a specific period of time.
- Lifetime – payments are made for the rest of your life.
- Tax Status
- Qualified – if the annuity is purchased with pre-tax or deductible dollars – such as a deductible IRA – it will grow tax-deferred. Distributions will be subject to income taxes.
- Non-Qualified – Earnings are grown tax-deferred and aren’t subject to income taxes during distribution.
Comparison of Annuities
As stated before, there are several types of annuities. They can generally be broken down into three kinds: fixed, indexed, and variable. The table below shows a comparison of these three along with their features.