The Basics of Annuities
An annuity lets you invest money for retirement tax deferred and receive regular payments — immediately or sometime in the future — from an insurer for a specific period or for life. You may also decide whether to buy an annuity that invests your money conservatively or aims for higher returns in the stock market.
Essentially, an annuity is a tax deferred investment with an insurance component that you pay into, either all at once or in installments. You generally buy an annuity from a financial advisor or broker.
The money you invest in an annuity has the opportunity to grow tax deferred. If you die before receiving any annuity income, your beneficiary generally receives all the money you put in — sometimes even if the contract is worth less than the amount you invested.
With some types of annuities, the underlying value (the principal) may fluctuate, but the income you receive is usually guaranteed. Please note that withdrawals of earnings are subject to ordinary income tax. In addition, a federal 10% penalty may apply to withdrawals taken prior to age 59½ and surrender charges generally apply.
Different types of annuities offer different income options:
- Immediate annuity income options
With immediate annuities, you invest a lump sum (typically $5,000 and up) all at once and begin receiving income payments as early as 30 days later. These payments can be for a specific period (such as 10 years) or for life.
For example, if you are age 65 and invest $300,000 this year, you might receive around $1,700 monthly for the rest of your life, based on today’s interest rates.
Immediate annuities can also guarantee an income to your spouse or partner if you die before he does. You might consider an immediate annuity if you’re concerned about outliving your savings.
- Fixed annuity income options
Fixed annuities pay a guaranteed interest rate for a fixed period (usually five to 10 years) and have a minimum rate guaranteed for renewal. Fixed annuities are designed to preserve your initial investment while interest compounds tax deferred.
When you are ready to receive the income, you have the option of regular payments for a specific period or for life. You can also take payments from the contract until it no longer has value.
- Variable annuity income options
Variable annuities are invested in the bond and equity markets and may fluctuate in value. These products are designed to provide income immediately or down the road when you need it.
They are sold with a variety of additional features, for an added cost, that let you tailor your investment to meet your income needs. For example, if you would like to start taking income in 10 years, there are variable annuities with insurance components that will guarantee an income value to withdraw from in a set number of years. Depending on the option chosen, the income may last for a set number of years, for your lifetime or your lifetime and the lifetime of your spouse. A nice feature of this type of income source is the opportunity for your payout to increase in retirement if your underlying investments perform well. Keep in mind that the income value is not cash and cannot be taken as a lump sum; it may only be taken as income.
That depends on a lot of factors, but the most important is how the money is invested. And that comes down to whether you’re buying an immediate, fixed, or variable annuity.
- Immediate annuity payments
Immediate annuities offer the least amount of control over your assets, because the issuing insurance company turns your investment into an immediate stream of income. The amount of income you receive from an immediate annuity depends on the payment option you select, your age, and the interest rate at the time of purchase.
- Fixed annuity payments
Typically, the insurer invests your money in conservative, fixed-rate investments, such as bonds. The exact amount of your payment is determined when you’re ready to start taking income. The insurance company will then look at the value of the annuity, the payment options you select, your age, and the interest rates. If you decide to withdraw income periodically, your money stays invested until the annuity no longer has value because of the withdrawals.
Fixed annuities may have a higher initial interest rate, which is guaranteed for a limited period only. At the end of the guarantee period, the contract may renew for a lower rate.
- Variable annuity payments
With a variable annuity, you can decide how the insurer will invest your money by choosing among subaccounts that buy stocks, bonds, or a combination of the two. Your income will be determined in part by the performance of the underlying investments, as well as any additional income benefits you purchase, so the amount varies for each person.
Variable annuities are long-term investments suitable for retirement funding and are subject to market fluctuations and investment risk.
Guarantees are based on the claims-paying ability of the issuing insurance company. Guarantees apply to minimum income from an annuity; they do not guarantee an investment return or the safety of the underlying funds.
A Guaranteed Minimum Income Benefit (GMIB) feature is an optional rider on a variable annuity that is available for an additional annual charge against the income base. It generally may only be selected at the time of contract purchase and cannot be changed later. It can usually be exercised only after a waiting period. A GMIB feature is not a cash or account value. Please be advised that depending on the performance of the investment option selected, the contract value at the time of annuitization could be such that the investor would incur a higher expense with the GMIB option without receiving any additional benefit.
Immediate annuities do not have fees or surrender charges if you take money out before a certain time. However, your options for taking money out of an immediate annuity are very limited.
Fixed annuities do not charge fees, but may have surrender charges during the guaranteed period.
Variable annuities have mortality and expense fees and annual management and investment fees. Surrender charges could be as much as 10% of the value of the annuity. If you buy extra features, you may pay additional fees for them.
Yes, like other types of retirement investments, you’ll pay a 10% federal tax penalty if you withdraw money from your annuity before turning 59½.
Yes. You’ll want to be sure the insurance company is considered financially sound, so you’ll feel confident that the insurer will stay in business while you invest and during the years you expect to receive income payments.
Look for insurers with an A rating or better from the independent rating agencies A.M. Best, Fitch Ratings, Moody’s Investors Service and Standard & Poor’s.
If your insurer does run into trouble, your state may provide protection through its insurance guaranty fund. Most states insure up to $100,000 (or more) of the present value of an annuity contract.
Yes. Meet with a financial advisor to discuss whether an annuity makes sense for your retirement planning and the type of annuity that might be best for you. Financial Advisors at Wells Fargo Advisors are members of one of the largest full-service retail brokerage firms in the country. They’re part of Wells Fargo & Company, one of the nation’s largest and strongest financial institutions, which has been in business since 1852.