Find Income for Life
Annuities offer a practical way to protect a portion of your retirement income. Here’s an explanation of the three main types of annuities, the ways you can withdraw income, and which annuity might be best for you.
Yet annuities offer a sound, practical way to help protect a portion of your retirement income. Here is a plain-English guide to these products.
An annuity is an investment, with an insurance component, that you pay into either all at once or in installments. With most annuities, once you reach a certain date you receive payments for a set period of time — often (and here’s the appealing part) for the rest of your life.
An insurer issues the annuity contract, but you generally buy an annuity from a financial advisor or broker.
“With annuities, you’re saying to yourself, ‘Here’s the protection I need down the road,’ ” says Joel Jessen, an annuity product manager at Wells Fargo. “‘I expect I will have X amount of expenses when I retire, and an annuity can give me a steady flow of income to help cover that need.’ ” Another big draw: Earnings can grow tax deferred until payments start.
Keep in mind that with most annuities, the underlying value, or principal, will fluctuate with the market's ups and downs. But the income you receive is usually guaranteed.
There are dozens of annuity options with various terms, time limits, and special features. Here’s a cheat sheet on the three main types: immediate, fixed, and variable.
- Immediate annuity You invest a lump sum, and your regular payments can begin right away. How long you receive payments and the amount of the payments depends on the sum of money you invest, your age, the terms of the annuity contract, and where interest rates are.
Could be a consideration for: Retirees ready to withdraw from an IRA or other retirement account who want to know the exact amount of money they’ll receive each month.
- Fixed annuity A fixed annuity pays a guaranteed rate of interest for a specified period of time. That interest compounds tax-free. After this period, the annuity can be turned into steady income, or taken as cash when you are 59½ years old. For example, if a 60-year-old woman invests $250,000 in a five-year fixed annuity today and earns 3% each year, she would have $289,819 at the end of five years to either turn into retirement income; take as cash; or move into another fixed, immediate or variable annuity, without tax consequences.
Could be a consideration for: A retiree or near-retiree who wants to avoid the stock market and is looking for a predictable rate of return. Keep in mind that the income from a fixed annuity rarely offers protection from inflation. In other words, if you lock in a low rate and rates rise, you won’t be able to take advantage of higher yields.
Fixed annuities may have a higher initial interest rate that is guaranteed for a limited time period only. At the end of the guarantee period, the contract may renew at a lower rate.
- Variable annuity This kind of annuity allows you to choose from a group of subaccounts, which are usually invested in stocks, bonds, or both. The subaccounts can hold everything from aggressive to conservative investments, depending on what you choose to match your own risk tolerance.
Variable annuities come in many flavors, with optional extras, including income benefits that guarantee minimum payments, bonus credits that increase your initial investment, and death benefits for your heirs. These extras come with additional costs.
If you decide to take income from a variable annuity, the amount you’ll receive can depend on a variety of factors, including the value of the underlying subaccounts and any additional features you have purchased in your contract.
Could be a consideration for: Women who want to take advantage of the growth potential of the stock market.
A variable annuity with an income benefit can be a good idea for a woman planning for retirement in the next 10 years or so, says Jessen: “With variable annuities, you have the opportunity to grow your underlying assets with exposure to the stock market. But if the market has the kind of colossal downturn we’ve seen recently and you’re retiring at just the wrong time, you’ll know you have income protection.”
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.
The death benefits guaranteed by the insurer to be paid to your heirs does not apply to the investment return or safety of the underlying funds in the variable annuity, as the annuity is subject to market risk during the life of the investor.
Variable annuities are long-term investments suitable for retirement funding and are subject to market fluctuations and investment risk.
Read your annuity contract closely, and be sure to discuss these potential trouble spots with your financial advisor.
- Surrender charges With most annuities, your money is locked up for a set period. If you withdraw early, you’ll pay as much as 15 percent of the value of your annuity. In addition, if you haven’t reached age 59½, you’ll pay the IRS a 10 percent penalty on any earnings in addition to ordinary income tax.
- Fees Some variable annuities come with a long list of fees. There’s a mortality and expense fee associated with managing the annuity, management fees for all the subaccounts in which your annuity is invested, and fees for any additional features. This can add up to as much as 2 percent to 3 percent a year. Your advisor should be able to say if a particular variable annuity is worthwhile for you.
- Financial strength of the insurers You’re handing over your money with the expectation that the insurance company you sign with will still be around years from now. So you want to be sure you’re investing with a solid firm.
Look for insurers with an A rating or better from A.M. Best, Moody’s, Standard & Poor’s, or Fitch Ratings.
In the rare event that 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. Check your state at annuityadvantage.com.
|Fixed annuity||Variable annuity||Immediate annuity|
|May be a consideration if||You seek to increase your tax-deferred earnings with low-risk investments and are comfortable with moderate returns||You want more tax-deferred earnings and are able to withstand market ups and downs in exchange for the long-term growth potential of the stock market||You want to convert your accumulated assets to a reliable income stream that can start within 30 days after you establish the annuity|
|Risk factors||Locked in for one or more years; often offers no inflation protection||Typical risk associated with subaccounts that range from money market investments to stock investments||Low control over investment; little inflation protection|
|Sales charges||None||Varies||Typically, none for fixed annuities; charges vary for variable|