ANNUITIES AND RETIREMENT PLANNING
You may have heard that IRAs and employer-sponsored plans (e.g., 401(k)s) are the best ways to
invest for retirement. That’s true for many people, but what if you’ve maxed out your contributions to
those accounts and want to save more? An annuity may be a good investment to look into.
Get the lay of the land
An annuity is a tax-deferred investment contract. The details on how it works vary, but here’s the general idea. You invest your
money (either a lump sum or a series of contributions) with a life insurance company that sells annuities (the annuity issuer).
The period when you are funding the annuity is known as the accumulation phase. In exchange for your investment, the
annuity issuer promises to make payments to you or a named beneficiary at some point in the future. The period when you are
receiving payments from the annuity is known as the distribution phase. Chances are, you’ll start receiving payments after you
Understand your payout options
When you surrender the annuity for a lump sum, your tax bill on the investment earnings will be due all in one year. The other options on this list provide you with a guaranteed stream of income. They’re known as annuitization options because you’ve elected to spread payments over a period of years. Part of each payment is a return of your principal investment. The other part is taxable investment earnings. You typically receive payments at regular intervals throughout the year (usually monthly, but sometimes quarterly or yearly). The amount of each payment depends on the amount of your principal investment, the particular type of annuity, the length of the payout period, and other factors.
Consider the pros and cons
An annuity can often be a great addition to your retirement portfolio. Here are some reasons to consider investing in an
But annuities aren’t for everyone. Here are some potential drawbacks:
Choose the right type of annuity
If you think that an annuity is right for you, your next step is to decide which type of annuity. Are you overwhelmed by all of the
annuity products on the market today? Don’t be. In fact, most annuities fit into a small handful of categories. Your choices
basically revolve around two key questions.
First, how soon would you like annuity payments to begin? That probably depends on how close you are to retiring. If you’re
near retirement or already retired, an immediate annuity may be your best bet. This type of annuity starts making payments to
you shortly after you buy the annuity, typically within a year or less. But what if you’re younger, and retirement is still a long-
term goal? Then you’re probably better off with a deferred annuity. As the name suggests, this type of annuity lets you
postpone payments until a later time, even if that’s many years down the road.
Second, how would you like your money invested? With a fixed annuity, the annuity issuer determines an interest rate to credit
to your investment account. An immediate fixed annuity guarantees a particular rate, and your payment amount never varies.
A deferred fixed annuity guarantees your rate for a certain number of years; your rate then fluctuates from year to year as
market interest rates change. A variable annuity, whether immediate or deferred, gives you more control and the chance to
earn a better rate of return (although with a greater potential for gain comes a greater potential for loss). You select your own
investments from the subaccounts (which invest directly in mutual funds) that the annuity issuer offers. Your payment amount
will vary based on how your investments perform.
It pays to shop around for the right annuity. In fact, doing a little homework could save you hundreds of dollars a year or more.
Why? Rates of return and costs can vary widely between different annuities. You’ll also want to shop around for a reputable,
financially sound annuity issuer. There are firms that make a business of rating insurance companies based on their financial
strength, investment performance, and other factors. Consider checking out these ratings.