Annuities stand alone in terms of their certainty – they offer guaranteed income for the rest of your life. Almost no other financial product on the market has their level of stability. Yet, in this age of financial ambiguity and roller-coaster stock market returns they aren’t always considered as part of a retirement package and are often overshadowed by IRAs and 401(k)/403(b)s. But neither of those products has the guarantees that an annuity has – they are based an projections and estimations rather than rock-solid returns. An annuity is a guaranteed contract between you and the provider. In the exchange for an immediate sum or deferred payment the provider of an annuity will guarantee an amount of income for the rest of your life.
There are some key points to understand about annuities:
An annuity is one of two different types:
- Immediate: An immediate annuity is one that is purchased using a single payment and begins payments immediately.
- Deferred: A deferred annuity has two phases – an accumulation phase where your investment earns interest on a tax-deferred basis and a distribution phase that pays out the annuity for either a set amount of time or for the rest of your life. The accumulation phase can be funded by either a single premium or by installments.
Annuities also are divided into different categories under the above types:
- Fixed annuities function similar to a CD where the insurance company will credit your investment with a set interest rate for the duration of the accumulation phase. This allows the payout amounts to be determined ahead of time due to the set interest rate.
- Indexed annuities have their interest rate tied to but not directly invested in a stock market index such as the S&P 500. This option offers a guarantee of no loses and some of the returns generated by the index and is used mainly to grow the initial investment and offset the effects of inflation.
- Variable annuities are invested directly in the stock market via either mutual funds, ETFs, stocks, bonds, or similar investment vehicle. They require a securities license to sell as their returns are not guaranteed and the risk falls solely on the purchaser. These offer the potential of greater returns than either indexed or fixed, but can potentially lose value.
There are also several payout options for each of the above:
- Period Certain: Payments are guaranteed for a specific amount of time ( like 20 years). If you happen to die before the period is over your designated beneficiary will receive the remainder of the payments.
- Lifetime Payments: This is a guarantee that you will receive income for as long as you live and the payments will vary depending on the accumulated amount and your life expectancy. At death the payments will stop and your spouse and/or heirs do not receive anything.
- Life with Period Certain: A combination of the above two options where your payout is guaranteed for the rest of your life and includes a period certain clause that ensures your beneficiaries will receive payments for the remainder of the period if you die before the period ends. For example, a life with a 15 year period certain will pay your beneficiaries for 10 years if you die five years after starting to receive payments.
- Joint and Survivor: This type of payout is an extension of lifetime payments that ensure your beneficiary (typically your spouse) will receive income for life after you pass away.
An annuity is a tool in your financial toolbox and we’re here to help you understand if it helps your situation. We understand that annuities can be complicated but we’re here to ensure that you understand all the pros, cons, and reasons for why an annuity may fit into your financial picture. If you have any questions or would like to learn if this is a product for you, contact us and we’d be happy to walk you through your options.