Annuities for Retirement Income
An income stream you cannot outlive. That sums up the appeal of an annuity. If you are interested in steady retirement income (and the potential to defer taxes), you might want to look at the potential offered by annuities. Before making the leap, however, understand how they work.
What is an annuity? It is an income contract you arrange with an insurance company. You provide a lump sum or continuing contributions; in return, the insurer agrees to pay you a specific amount of money in the future, usually per month. If you are skittish about stocks and searching for a low-risk alternative, annuities may appear very attractive.2
Immediate or deferred? With an immediate annuity, payments to you begin shortly after the inception of the income contract. With a deferred annuity, you make regular contributions to the annuity, which accumulate on a tax-deferred basis for a set number of years (the accumulation phase) before payments to you begin.1,2
Fixed or variable? Fixed annuities pay out a fixed amount on a recurring basis. With variable annuities, the payment can vary: these investments have a toe in the stock market. The insurer places some of the money that you direct into the annuity into Wall Street investments, while promising to preserve your capital. Some variable annuities come with a guaranteed income benefit option: a pledge from the insurer to provide at least a certain level of income to you.1,3
In addition, some annuities are indexed. These annuities can be either fixed or variable; they track the performance of a stock index (often, the S&P 500), and receive a credit linked to its performance. For example, if the linked index gains 8% in a year, the indexed annuity may return 4%. The return is less than the actual index return, because the insurer usually makes you a trade-off: it promises that you will get at least a minimum guaranteed return during the early years of the annuity contract.3
Long-term commitment. Insurance companies expect annuity contracts to last for decades. If you change your mind and decide to cancel an annuity contract a few years after it begins, you may have to pay a surrender charge, a penalty. (Most insurance companies will let you withdraw 10-15% of the money in your annuity without penalty in an emergency.) Federal tax law also discourages you from withdrawing money from an annuity: if the withdrawal happens before you are 59., you are looking at a 10% early withdrawal penalty, like the ones for traditional IRAs and workplace retirement accounts.1,3
“Bells and whistles.” Some offer options to help you pay for long-term care. Some set the length of the annuity contract, with a provision that if you die before the contract ends, the balance remaining in your annuity will go to your estate. In fact, some annuities work like joint-and-survivor pensions: when an annuity owner dies, payments continue to his or her spouse. (Generally, the more guarantees, riders, and options you attach to an annuity, the lower your income payments may be.)1
Potential for great tax savings. The younger you are when you arrange a deferred annuity contract, the greater the possible tax savings. Like a tax shelter, its earnings grow without being taxed; they are only taxable once you draw an income stream from the annuity. If you start directing money into a deferred annuity when you are young, that money can potentially enjoy many years of tax-free compounding. Also, your contributions to an annuity may lower your taxable income for the year(s) in which you make them. While annuity income is regular taxable income, you may be in a lower tax bracket in retirement than when you worked.1
Minimums and fees. The fee to create an annuity contract is often high compared to fees for establishing investment accounts—sometimes as high as 5-6%. Annuities typically call for a minimum investment of at least $5,000; an immediate annuity demands a five- or six-figure initial investment.3
No investment is risk free, but an annuity offers an intriguing investment choice for the risk averse. If you seek an income-producing investment that attempts to limit or minimize risk, annuities may be worth considering.
This material was prepared by Marketing Pro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate; however, we make no representation as to its completeness or accuracy. Please note: investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting, or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax, or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.
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