Many retirees and older Americans include annuities as part of their retirement package. It is a type of income designed to support you throughout your lifetime or for a designated period of time.
Many people refer to them as “pension annuities” or a “retirement annuities” because they are very similar. In its most basic form, an annuity plan is a contract you can purchase from an insurance company. You pay the insurance company a lump sum and, in return, receive fixed-income payments.
How do annuities work?
Annuities provide a fixed income stream to help retirees pay for essentials after they stop working. They are designed to protect individuals from outliving their retirement package. People are living longer than ever before, and running out of money in retirement is a common fear among many.
When you purchase or make contributions to an annuity plan, the payments are not taxed. That’s why an annuity is known as a tax-deferred account. Your money grows faster in tax-deferred accounts because you are not losing any to the government.
When you start to receive your annuity payments, only the earnings are taxed – not the principal. That means that the original lump sum, along with any contributions you made, will not be taxed when you begin receiving payments.
How much does an annuity cost?
You can purchase a retirement annuity using a sum of cash from your retirement nest egg. You can typically choose how much money you want to purchase the annuity contract for, but many insurance companies have a minimum annuity amount. For example, Charles Schwab has a $100,000 purchase minimum for all annuity contracts.
The total amount of money you pay for an annuity plan impacts the monthly income payments you will receive once the annuity begins. In general, the more you pay for your annuity, the higher your monthly income payments will be. Similarly, if you make more contributions to your tax-deferred account, you
All of the following factors determine how much you should pay toward an annuity:
- The length of time you want the annuity to last.
- If you want the annuity to cover just you or you and a spouse.
- The amount of money per month you want to receive when the annuity begins.
- The date you want to start receiving payments.
- The type of annuity you plan to purchase.
Types of Annuities
There are two primary types of annuities: immediate and deferred.
An immediate annuity begins as soon as you purchase the contract. Once you pay the immediate annuity sum to the insurance company, you can start receiving payments. This type of annuity may be best if you are at or nearing retirement age.
A deferred annuity begins on a predetermined date, usually, years after the contract is purchased. This type of annuity may be best if you are nowhere near retirement age.
When you purchase a deferred annuity, you can make consistent contributions into a tax-deferred annuity account for a set period of time. The goal of investing in a deferred annuity is to choose investments that will help your contributions grow.
Other Types of Annuities
Under each category listed above, there are various other types of annuities that vary in how you will receive your payments.
A fixed annuity is one that provides you with fixed payments throughout the length of the annuity. If you choose this option, you will receive the same monthly payment each month throughout your lifetime.
However, you may be able to opt for a fixed annuity that accounts for inflation. These purchase options tend to cost more because your monthly payments will grow with inflation.
A variable annuity is the opposite of a fixed annuity in that your monthly payments will vary depending on the market. When you purchase a variable annuity, your money is tied to investments. These investments determine how much money you receive each month.
There is some risk with variable annuities. If the investments do not perform as well as expected, your monthly payments could be reduced. On the other hand, however, your monthly payments could grow dramatically if the investments perform well.
When it comes time to receive your annuity plan payments, you have a few different options. The process of breaking down annuities into monthly payments is called “annuitization.” Your payments become “annuitized” for a certain period of time, which is typically an option you choose during the purchase of the contract.
For example, you might purchase a deferred annuity that pays you monthly for the remainder of your lifetime. Or, you might choose an immediate annuity and receive payments for a set period time, like 15 years.
If you need access to more money than what you receive each month, many annuities allow you to make withdrawals. However, it is important to understand the withdrawal process before purchasing an annuity.
Annuity Withdrawals and Tax Penalties
Do you need a lump sum of cash? Many annuities permit you to make withdrawals as needed, though some may limit the number of withdrawals in a given period of time.
However, keep in mind that when you withdraw pre-tax money from your annuity, you will need to pay regular income tax. Plus, if you make a withdrawal and you are younger than 59 ½ years of age, you may be subject to an additional 10 percent penalty tax from the IRS.
What happens to your annuity after you die?
Many annuities act as both investment and insurance, which means you can designate a recipient to receive the remainder of your annuity after you die. This individual is known as an annuitant beneficiary.
If you are concerned about dying shortly after purchasing an annuity, you may have the option to purchase a period of the certain annuity. This means that you would receive a guaranteed amount of money for a designated period of time, regardless of when you die. You can name a beneficiary who will receive payments after your death until the end of the period.
There are a few drawbacks to consider. Period certain annuities tend to cost more because they are guaranteeing more money. Likewise, monthly payments may be smaller than a lifetime annuity.
What are the best annuities on the market?
Choosing the right retirement annuity for you is a personal choice. After considering your preferences and talking with a financial advisor, it’s time to find a company you’d like to work with.
The best annuities have multiple options, flexibility and transparent policies. Here are some of the most popular annuity plans in 2022:
- Athene Annuity – Athene is one of the leaders in offering annuities and various other retirement plans. The Athene annuity received a mark of Excellent from AM Best, a leading credit rating agency.
- Transamerica Annuities – If you are considering a variable annuity, you may want to look into Transamerica. Transamerica annuities are only offered as a fixed annuity, so be sure to explore your options.
- Allianz Annuity – Allianz offers a fixed annuity as well as an index variable annuity, offering you the flexibility you may be looking for.