Retirement Annuities Offer a Steady Stream of Income at a Price
Retirement annuities involve a long-term contract with an insurance company designed to provide a steady income stream in retirement. As an investor, you can make one lump-sum payment. Or you can make a series of contributions. Pre-retirement, your investment grows tax-deferred.
Once you retire, the insurer makes regular payouts that can last for life. Those payments can be a set amount every period – most often monthly – or variable. An annuity is designed to give you a guaranteed income (like a pension would be).
Types of Retirement Annuities
A fixed annuity often appeals to investors who are averse to the risk of an up-and-down stock market. A fixed annuity is structured to have a guaranteed rate of return and consistent, predictable payments. Your principal never drops due to market changes.
A variable annuity invests your savings in the market, providing potential for higher growth but carrying greater risk to the principal and fluctuating payouts.
The payments from single life annuities end on the investor’s death. Joint and survivor annuities pay the original investor for his or her life. After he or she dies, a second annuitant receives a fixed amount at regular intervals. This amount, paid for the life of the second annuitant, may be the same or different from the amount paid to the first annuitant
Immediate annuities begin payments within a year, while deferred annuities allow your contributions to grow for several years before payments start.
The Caveats to Retirement Annuities
Annuities have several benefits – a lifelong income, deferred taxes, a guaranteed rate of return and the possibility of growth. But there can be several disadvantages.
Retirement annuities can have complicated contracts with lots of riders and extra provisions. Fees can be high, with commissions and penalties built in.
Investors can face problems if they need sudden access to their funds. An annuity isn’t designed to be liquid. You usually can’t take out any money at all in the first year. And if you take out money while your investment is still accumulating, you’ll incur surrender charges, which can be very high. You may end up with significantly less money than you started with.
There is also no accounting for inflation. As for taxes, the situation can also be complicated. But your payments will be taxed as ordinary income, which involves a higher tax rate than capital gains taxes on traditional investments.
Talk with a vetted financial advisor to see if an annuity makes sense as part of your retirement portfolio.
Links
IRS Publication 575 has information on how annuities are taxed.
This calculator helps you compare a taxable investment to a tax-deferred annuity.
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