“Annuity” is one of those words that we think of as being discussed at the “grownups’ table.” Primarily used as a guaranteed income stream during retirement, in today’s current climate of bank failures, an annuity just might be the safe harbor you are looking for.
Understanding Annuities
An annuity is a contract between you and an insurance company, bank, brokerage firm, or mutual fund company that guarantees an income stream in retirement. You pay a lump sum or you make a series of payments to an issuing company during what is called the accumulation phase. The Internal Revenue Service (IRS) allows you to delay any tax on an annuity’s earnings until you withdraw them, but if you are under age 59.5, you will most likely incur a 10% early withdrawal penalty.
The issuing company will invest your premium in a mutual fund that holds stocks, bonds or other investments, and after a set period of time, the payout phase begins in which the company:
Pays you a fixed, one-time amount
Makes payouts for a specified period (usually 10, 15 or 20 years), and if you die before the end of a specified period your beneficiary receives the payouts until the period ends
Makes payouts to you for as long as you live, with no payouts to your heirs
Makes payouts to you or your beneficiary for as long as either of you lives.
How much you will ultimately receive from an annuity is determined by an annuity calculator that makes use of the following information:
Your beginning contribution age
Your expected retirement age (when you want to start receiving the annuity)
The investment rate of return
Your annual contribution
Any lump sum contribution.
Types Of Annuities
There are two basic types of annuities depending on when payouts begin:
Deferred annuities: You don’t pay taxes on the annuity’s contributions or earnings until payouts begin
Immediate annuities: Turn a lump sum into an income stream, possibly for the rest of your life.
Within those two basic types of annuity are three additional types that specify the rate of return:
Fixed: Provide a guaranteed minimum interest rate, investment risk is borne by the insurance company and not by you, if investment performance is higher than the guarantee, the company makes money, if it is less, the company loses money; these annuities are regulated by individual state’s insurance commissioners.
Variable: Allows you to invest in various mutual funds and unlike other annuities, you bear the investment risk rather than the insurance company, but this type of annuity has the potential to increase in value. Variable annuities are regulated by the Federal government’s Security and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).
Indexed: Gains or losses are based on returns of indexes, such as the S&P 500 or the Nasdaq Composite. If the index goes up, the value of your annuity goes up while any downside is to a specified floor; indexed annuities are regulated by individual state’s insurance commissioners.
Especially for variable annuities, it’s a good idea to learn about the mutual funds in which you’ll be investing. Mutual funds are required by law to file both a prospectus and shareholder reports with the SEC.
With inflation running high at 4.9%, dividend stocks offer one of the best ways to beat inflation and generate a dependable income stream. Download Five Dividend Stocks To Beat Inflation, a special report from Forbes’ dividend expert, John Dobosz.
Best Annuities For Reliable Income
Because they are tied to market conditions, annuity rates are constantly changing, so how do you know which annuity is right for you? The answer is to go with a well-respected company such as the ones listed below, and to pay attention to insurance company ratings provided by AM Best.
As of May 2023, the best annuity providers include:
Fidelity: Offers six annuities within three types; has low fees, especially for account transfers; has a high customer service rating; A+ AM Best rating.
New York Life: Provides both fixed and variable annuities, with their variable annuities offering returns of up to 8%; allows withdrawals of up to 10% of the account value for those above 59.5 years of age; A++ AM Best rating.
Allianz: Offers seven annuity choices; charges no annual fees on its fixed indexed annuities and they pay a bonus on interest earned by indexed assets; A+ AM Best rating.
USAA: Its Single Premium Immediate Annuity (SPIA) offers a lifetime guaranteed income with no annual fees; provides a guaranteed minimum interest rate; A++ AM Best rating.
Mass Mutual: Partially owned by its members, the company offers deferred fixed, variable, fixed index and both immediate and deferred income annuities; high customer service ratings; A++ AM Best rating.
American National: Offers some of the highest returns at 4.65% on a premium of only $5,000, with no annual fee or percentage; it does charge an upfront 2.5% sales commission; A AM Best rating.
Choosing the Right Annuity
Before shopping for an annuity:
Determine how much financial risk you’re willing to take.
Be sure to purchase from a company that is licensed in your state.
Pay attention to the free-look period, which is a period during which you can cancel your annuity contract; the period differs state by state.
If you’re unsure of the tax consequences of an annuity, consult a financial advisor or a tax professional.
Ask about any fees, and determine what the surrender period is and what charges will be incurred.
With inflation running high at 4.9%, dividend stocks offer one of the best ways to beat inflation and generate a dependable income stream. Download Five Dividend Stocks To Beat Inflation, a special report from Forbes’ dividend expert, John Dobosz.
Annuity Pros And Cons
Pros:
An annuity provides guaranteed, predictable retirement income.
By giving up the liquidity of your money, you are hedging your longevity risk, that is, the chance of you outliving your savings.
Unlike other tax-advantaged retirement accounts, annuities have no annual contribution limit and can be an attractive alternative if you’ve maxed out your 401(k) and IRAs.
Annuities are useful for those receiving a financial windfall, such as an inheritance, a settlement or a lottery win.
Cons:
Like all investments, annuities carry some level of risk.
The ability of the issuer to make future payouts is dependent on their current and future financial health; third parties such as Standard & Poor or Moody’s provide financial strength ratings.
Once you purchase an annuity, your cash is no longer liquid and it is subject to early withdrawal charges, penalties and taxes; withdrawals are subject to ordinary income tax and if taken before age 59.5, may be subject to a 10% IRS penalty.
The duration of annuities is long, especially for variable annuities, and if you withdraw your money during the surrender period, which ranges from two to more than ten years from the date of purchase, you will incur a surrender charge of up to 20%.
Annuity fees are taken out of your balance and can be easily overlooked, they can include an administrative fee, mutual fund fees, transfer fees and insurance risk fees; according to a Morningstar December 2021 report, the national industry average fee is 1.04% annually, while Fidelity’s rate was only 0.25%.
Annuity FAQs
What is an annuity and how does it work?
An annuity is an investment option that can provide a guaranteed income for both you and your spouse throughout your lifetimes.
What are the different types of annuities?
The primary types of annuities are fixed, which guarantees a fixed interest rate; variable where returns fluctuate with the market; and indexed where returns are dependent on the behavior of an index such as the Standard & Poor’s 500.
What are the benefits of annuities for retirement income?
Benefits include deferred taxes on your investment gains, the protection of your principal, the potential for guaranteed lifetime income and the ability to provide for your heirs.
What are the drawbacks of annuities?
Loss of liquidity, long duration and high fees are the main drawbacks of annuities. Also you must wait until age 59.5 to withdraw any money from the annuity without penalty.
The bottom line is that annuities offer a safe haven for your assets, an additional way to save for your retirement and another way to receive income during retirement besides a pension and Social Security.
With inflation running high at 4.9%, dividend stocks offer one of the best ways to beat inflation and generate a dependable income stream. Download Five Dividend Stocks To Beat Inflation, a special report from Forbes’ dividend expert, John Dobosz.
