An annuity is a life insurance product that pays out income after age 59.5. The major draw of fixed annuities these days are the guaranteed interest rates and guarantee of income for life and/or, period certain.
The size of your payments are determined by a variety of factors, including how much you invest and the length of your payment period (determined between you and your insurance agent) or whether you want to receive payments for the rest of your life or for a set number of years. How much you receive depends on whether you opt for a guaranteed payout (fixed annuity) or a payout stream determined by the investment performance of your annuity (variable annuity).
Annuities can be funded over time or with one payment. For instance, if you are in your 40’s and want to prepare for your 60’s, you might be in a position to make monthly investment payments. You can also fund an annuity by purchasing it in one lump sum (single premium deferred annuity or single premium immediate annuity) if you have just come into some money (an inheritance or large sale) and want to prepare for your retirement.
Annuities can be paid out monthly, quarterly or annually. They can also be paid out in one lump sum, but most people choose the monthly payout method.
Advantages of Having An Annuity
The money you invest into an annuity is considered tax sheltered income and works wonderfully for people in high tax brackets. This means when you file your taxes, any amount you paid into your annuity, and the interest earned, for the year is tax deductible. Also, there is no maximum limit as to how much you can invest each year, as there is with a 401K, and the amount the annuity earns is also not taxed. Annuities are not taxed until you begin receiving payments at age 59.5 or later.
Another advantage to an annuity is since there is no limit as to much you can contribute each year, they allow people who are starting to invest late in life to catch up.
Finally, how you choose to spend your annuity is up to you. For instance, long term care insurance policies are restricted to the parameters of long term health care costs.
The main disadvantage of purchasing an annuity are the rather steep surrender charges you will receive if you take out your money before age 59.5, especially the first 1-8 years of investing. The surrender charge is about 7% of your account value if you leave after one year and then they generally decline by one percentage point a year until it gets to zero after year seven or eight.
You want to make sure you have the income to invest in an annuity to avoid those surrender charges! However, generally after 8-10 years, the surrender charges are waived but you will be hit with the taxes on the money you receive.
Two Different Types of Annuities
When you purchase a fixed-rate annuity, the risk belongs to the insurance company, not to you. You are not responsible for choosing the investments, the insurance company is. The insurance company agrees to pay you a pre-determined interest rate no matter if the investments gain or lose money.
When you opt for a variable or equity indexed annuity, the risk belongs to you and not the insurance company because you decide how to invest your money in the sub-accounts (essentially mutual funds) offered within the annuity. The value of your account when you start to draw on your annuity depends on the performance of the funds you chose (you also stand to earn more than a fixed annuity) and there is no guaranty of the fixed payment.
You should look at the amount of time you have to invest and your tolerance for risk when deciding on what kind of annuity is right for you.
Are You Almost Ready to Retire?
If you are a retired expatriate, or nearly retired, who wants to assure that the money will flow regardless of how long you live, an immediate annuity is a great way to insure monthly income.
Also, the greater you feel your chances are of living a long, vibrant life and the more worried you are about outliving your money, the more of your assets you might want to devote to an annuity.
For more information and to see if an annuity is right for you, please email us.