In short, annuities are insurance contracts that you'd make with an insurance company. Read here everything you need to know about annuity.

Annuity, Explained: Everything You Need To Know About Annuity

Did you know that millions of baby boomers retire in the United States every year? If you are thinking ahead and are looking at all of your options when it comes to saving for retirement, we are here to explain everything there is to know about an annuity option. 

Keep reading to learn what’s an annuity and the different types. 

What Is Annuity?

An annuity is an insurance contract that makes regular payments to someone at some point in the future or immediately. You can purchase annuities when you want to make your retirement savings grow or to protect your retirement money. The main thing to keep in mind is that an annuity is a contract between you and an insurance company. 

You can learn even more about annuity here. 

Annuity Types

There are three main types of annuities. These include fixed, variable, and indexed. Every type has its own payout potential and risk level. 

Fixed Annuities

There are two types of fixed annuities including a fixed deferred annuity and a fixed immediate annuity. A fixed deferred annuity means that you get paid later and an immediate annuity will pay you a fixed rate right now.

With a fixed annuity option you get paid a guaranteed amount of money. The main con of this type of annuity is that the annual return is not very high. It is usually just a little bit higher than a certificate of deposit (CD) from a bank. 

Variable Annuities

With this option, you have the opportunity to receive a larger return but you also have a higher risk. When you want a variable annuity option you choose from a menu of mutual funds that go into your sub-account. 

From there your payments when you retire will depend on how well your investments performed throughout the years. 

Indexed Annuities

The risk and reward potential of an indexed annuity is somewhere in the middle of a fixed and variable annuity option. You will have a guaranteed payout just like with a fixed annuity but a piece of your return depends on the performance of a market index. 

Keep in mind that with indexed options there are high fees and they can also be a bit complex to understand. If for any reason you have to withdraw money in the first few years of your contract you can expect to pay high surrender charges.

Taxes and Annuities

For every option, the balance that grows will be tax-deferred but when you start receiving disbursements, these are subject to income tax. You can expect your funds to be taxed at the regular income tax rates. If you hold your mutual funds for over a year then these will be taxed at the long-term capital gains rate. 

The capital gains rate is usually lower. Also, keep in mind that the money that you contribute to an annuity does not reduce your taxable income. It is best to buy an annuity after you have contributed the maximum possible amount to your pre-tax retirement accounts. 

Why Buy an Annuity?

One of the reasons to buy an annuity is for tax-deferred growth. Another reason is for long-term security because you never know what the future holds and inflation can really put a damper on people’s retirement when you do not plan for it. 

An annuity can also leave death benefits for your heirs and give you peace of mind that they are taken care of. Usually, if you are within a year of retirement and you want to have guaranteed income then you want to open up an income annuity. 

Benefits

Annuities allow you to save money without having to pay taxes on the interest until later on. Another benefit is that unlike an IRA or 401(k), you do not have contribution limits. 

With an annuity in place, you will not have to worry about outliving your savings. In your post-pension age, this is a huge advantage that you do not want to miss out on. 

Contract Riders

When you buy an annuity there are additional protections or benefits that you can attach to your contract if you choose. One of the categories is living riders, where you can provide benefits while you are still alive. The other category is death benefit riders which will protect the benefits of your beneficiary. 

An income rider has a guaranteed growth rate while it is in its deferral years. As soon as you start receiving income then the rate will stop growing. If you opt for a death benefit rider, if you happen to pass away before the annuity has paid you out all of your payments then the insurance company will pay your beneficiary or your estate the difference left. 

Keep in mind that every rider you choose will charge you an additional fee for the entire life of the policy. For example, if you turn on your income rider payments and your rate stops growing, you will still have to pay the fee in this case. 

Feeling Like an Annuity Pro?

We hope that now that we shared all of the ins and outs of an annuity, you can make informed decisions moving forward with your own annuity. If you do not have an annuity yet, then you can decide whether or not you need one and which type you prefer. 

Did you find this article useful? Please feel free to browse the rest of our finance section for our latest tips. 

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