Annuity Basics, the product whose value you may never outlive!
An annuity is a personal insurance product designed to provide income payments during retirement. Because it’s an insurance product, payments are guaranteed, and if chosen to, can continue at full value for one’s entire lifetime — no matter how long that may end up being.
According to an article titled “Practical Issues in Financial and Life Management for the Late-in-Life Population” by Anna Rappaport and Sally Hass from the Society of Actuaries, most people will live more than 20 years after an average retirement age of 65, and some will live up to 15 to 20 years after that — up to 40 years past retirement! Will saving during their working years be enough for a potentially long retirement? A lifetime income provided by an annuity may be an invaluable addition to one’s financial holdings.
Two Types of Annuities
Annuities issued by insurance companies are funded by the consumer and are guaranteed by the issuing insurance company. As an insurance product, the guarantee is backed by the claims-paying ability of the issuing insurance company. Unlike IRAs and other retirement plans with income and contribution limits, anyone can own an annuity and fund it as they see fit.
Annuities generally fall into one of two categories: Deferred and Immediate. While both provide instant value to the annuity owner, immediate annuities provide an immediate guaranteed income, whereas deferred annuities offer guaranteed tax-deferred growth of the premium, which may later be converted into a guaranteed income.
Funding a deferred annuity depends on how the insurance company has structured the product.
- Single-premium deferred annuities require one deposit made at the time of purchase.
- Flexible-premium deferred annuities allow deposits to be made over time.
Money in a deferred annuity grows according to the guarantees of the annuity contract and the earnings are tax-deferred. Being tax-deferred allows the annuity value to grow at an accelerated rate compared to earning the same growth rate in a taxable account.
During the time the annuity is deferred, the owner has the right to withdraw funds or convert the annuity into an immediate income. Any withdrawal is considered taxable, and because annuities are designed for retirement, withdrawals prior to age 59½ may also be subject to an additional 10% tax on earning.
An immediate annuity is designed for immediate income and may be purchased from an insurance company when income is wanted, or by converting the funds in a deferred annuity into an immediate annuity. With an immediate annuity, a portion of each payment is treated as return of principal and is not taxable.
Types of Annuity Payments
The amount of each annuity payment is determined by several factors, including the amount of funds deposited or accumulated, rate of return, and the length of your payment period.
The most valuable payment is a life-only income. Basically, if the individual with the annuity is alive, they will receive a payment — even if the cumulative payments already received far exceed the value of the deposits and earnings. For married couples, most insurers offer a life income that covers surviving spouses.
Other income payment methods include fixed periods such as 5, 10, 15 years or longer. These guarantees provide the income to be paid regardless of any other factors, including growth rates and mortality. For example, if a person chooses a 15-year income payout but does not survive beyond 6 years, the balance will be paid out to the beneficiary.
Growth, Taxes, and Guarantees
Annuities provide earnings in three general methods:
Each method has its own level of growth and income potential.
Fixed annuities earn a guaranteed rate of interest during deferral and income, whereas variable and indexed provide for potentially higher returns, generally without guaranteed growth rates. Fixed annuities generally provide guaranteed rates of return on an annual basis for multiple years. Multi-year rate-guaranteed annuities are known as MYGAs (multi-year guaranteed annuity).
Discover today how an annuity may enhance your future retirement — just ask your insurance agent!