An annuity is product of insurance that offers immediate tax-deferred income for retirement. The two main choices for an individual looking to purchase an annuity are whether to purchase a fixed or variable annuity. The decision to buy should be based on the individual’s retirement goals and current financial situation.
Types of annuities:
Fixed Annuity – guarantees a specific, fixed income stream to an investor for life or a specified period. The premiums paid by the investor to purchase this type of annuity provide a guaranteed amount when the contract is signed, called the ‘annuitant’s share.’ The issuer agrees to pay all costs associated with maintaining and paying interest on this investment. Examples of fixed annuities – traditional and index-linked – may be purchased at insurance companies, mutual funds, and banks.
Variable Annuity – is a contract where the amount of income the contract pays out over a given period is determined by an interest rate or factor. The annuitant may receive a fixed amount or select several periods of payments (i.e., one month, three months, six months) and receive the corresponding amount each period. Premiums paid to purchase this type of annuity provide the income and administration, and maintenance fees payable over the contract term.
Features of Annuities
To purchase annuities, investors should be comfortable with the tax implications of this type of investment. They should be aware that all payments made before reaching age 59½ are subject to a 10% tax penalty, and if only part of the payment is subject to the 10% early withdrawal fee, then only part of the payment will be disbursed. Most annuity products allow the annuitant to withdraw funds at any time without charge. The annuitant may even choose to take the remaining payments over a while to maximize returns.
Fixed annuities do not require significant amounts of money down at the outset. If an individual is planning to leave the money invested for several years, it may be possible to afford a decent rate of return without using all or most of the purchased amount.
Variable annuities require a more significant initial outlay but benefit greater flexibility. They can be purchased with money from various sources so that an investor has access to significant amounts without having to establish and maintain a line of credit or mortgage. The fixed and variable annuity industry does not permit investors/owners to split their initial or existing investments for tax purposes (e.g., if an investor/owner has $10,000 available for a variable annuity, they are unable to contribute $5,000 from one account and $5,000 from another).
Variable annuities can be transferred to other accounts without penalty. Investors should consider this possibility when deciding whether or not to purchase an annuity. An investor may move their money into an IRA after a certain number of years to avoid paying taxes on future payouts. The annuity then becomes part of an individual’s IRA.
Investors should consider their current financial situation before they purchase an annuity. Buying an annuity should be a part of a larger, long-term investment plan. Investors should always be sure that they understand the fees and taxes associated with an annuity to get the best available rate of return on their investment.
Fixed annuities offer a finite amount of money in exchange for a fixed rate of return over time (e.g., monthly payments at age 65). Variable annuities offer more flexibility but are riskier because value fluctuations depend on market conditions and interest rates. Variable annuities are not for everyone but can be an excellent investment for some individuals.
The best type of annuity for an individual is determined by their current financial situation and retirement goals. The best annuities offer a guaranteed rate of return and the benefit of tax-deferred growth for those who are eligible. For the most part, the smaller the investment amount, the better the financial outcome because that amount will likely compound into a more significant amount over time.
Annuities are a safe investment that grows more appealing as low-interest rates make the other investments less attractive.