Annuities generally fall into two categories: deferred and income.
Some will tell you annuities are the absolute best way to protect your money. Others will swear you are wasting your time and killing your investment potential.
Let’s break down annuities.
Each type of annuity works differently and offers unique advantages.
Tax-deferred annuities: for retirement savings
Deferred annuities can be a good way to boost your retirement savings once you’ve made the maximum allowable contributions to your 401(k) or IRA. Notice I said once you’ve MAXED OUT YOUR 401(k). Like MAX MAX.
Like any tax-deferred investment, annuity earnings compound over time, providing growth opportunities that taxable accounts lack.
Deferred annuities have no IRS contribution limits, so you can invest as much as you want for retirement. This is a plus. After you’ve explored other retirement options (401(k), IRA, 529, etc.), annuities are a good avenue to travel down.
You can also use your savings to create a guaranteed stream of income for retirement. Guaranteed is always good. In some cases, receiving that fixed income for an extended period of time gives people a sense of protection.
Depending on how annuities are funded, they may not have minimum required distributions (MRDs). This is important. If you don’t need the income, let it grow.
Bear in mind that withdrawals of taxable amounts from an annuity are subject to ordinary income tax, and, if taken before age 59½, may be subject to a 10% IRS penalty. Don’t do this. Get a second job if need be. Extend your withdrawals as long as you can.
The average life expectancy is hovering around 80 for men and women. Most retirement systems are designed to last 5-10 years.
Annuities also come with annual charges not found in mutual funds. These charges can eat your investment up. Get the charge information upfront.
Deferred variable annuities
These annuities have funds that may have the potential for investment growth.
However, this can involve some market risk and could result in losses if the value of the underlying investments falls.
Variable annuities are usually appropriate for those with longer time horizons or those who are better able to handle market fluctuations. Some variable annuities allow you to protect your investment against loss, while still participating in potential market growth. Those nearing retirement should steer clear of variable annuities.
Deferred fixed annuities
These annuities offer a guaranteed rate of return for a number of years.
Fixed deferred annuities may be more suitable for conservative investors or for those interested in protecting assets from market volatility.
In this way, they’re similar to certificates of deposit (CDs).
Deferred fixed annuities differ from CDs in that:
- Annuities are not FDIC-insured. This is a slight risk for investors, but shouldn’t scare you away.
- Withdrawals from annuities prior to age 59½ may be subject to a 10% IRS penalty.
- Deferred fixed annuities may offer more access to assets than a CD.
- Annuity earnings compound on a tax-deferred basis.
Income annuities: for income in retirement
Income annuities may be appropriate for investors in or near retirement because they offer guaranteed income for life or a set period of time. They may allow you to be more aggressive with other investments in your portfolio, since they provide a lifetime income stream.
Keep in mind that you may have limited or no access to the assets used to purchase income annuities.
Immediate fixed income annuities offer a guaranteed, predictable payment for life, or for a certain period of time. Your guaranteed income payment cannot be affected by market volatility, helping shield your retirement income from market risk.
A cost-of-living increase is available at an additional cost to help your buying power keep pace with inflation.
Deferred income annuities are fixed income annuities that have a deferral period before income payments start. Because of the deferral period, you may get a higher income payment amount than you would from a comparable immediate fixed income annuity with the same initial investment. The cost-of-living increase is also available at an additional cost for deferred income annuities.
So now you know annuities. Recent law changes make the fees for annuities much more palatable. Like all investments, do your research and speak to a professional who ISN’T selling anything.
Had positive or negative annuity experiences? Leave comments below.
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-B&T