Depending on your goals, an annuity can be an important and advantageous part of your financial plan, but there are a lot of misconceptions about annuities in the marketplace today.
Annuities offer two distinct retirement-planning benefits. First, investments in an annuity grow tax-deferred, meaning that you don’t pay taxes on earnings until you begin withdrawing them — with the restriction that if you withdraw money prior to age 59½, you’ll pay a penalty. Second, annuities can help meet your income planning needs by providing a guaranteed lifetime stream of income for both you and your spouse.
So, what are your options?
Below, I’ve listed the four main types of annuities with a quick summary of each.
- Fixed: The most conservative annuity option, fixed annuities are a contract with an insurance company which establishes a guaranteed range of interest they will pay for the life of the contract. It is reset every year on your anniversary date and is adjusted according to current market interest rates. Fixed annuities also provide tax-deferred growth and guaranteed income options, including the option to provide lifetime income for you and your spouse.
- Variable: With a variable annuity the return on your investment in the annuity account is not guaranteed or fixed, but varies based on the performance of underlying investments, or “sub-accounts.” Until recently, variable annuities were generally used by investors seeking exposure to equities (stocks) in a tax-deferred package. Today, in addition to tax deferral, variable annuities offer a wide variety of “principal protection” features that allow you to limit potential losses. Income riders are also popular, offering guaranteed crediting and lifetime income streams. There are, however, additional costs associated with these features.
- Indexed: The fixed index annuity was introduced in the mid-1990s. Instead of a fixed rate, the contract is linked to one or more equity indexes, such as the S&P 500 or the Nasdaq. You have the opportunity to limit your risk of loss by also agreeing to limit your gains. This is done by selecting “participation” and “cap” rates that offer the combination of risk protection and potential reward that fit your needs. Income riders with guaranteed crediting and lifetime income are also available.
- Immediate: These annuities are designed to pay the highest income amount immediately. By paying a lump sum up front, the annuity will annuitize or pay a fixed amount per month for life. With annuitization you generally must forfeit control of the principal amount to “purchase” this income stream. Immediate annuities offer various features for individual situations, including covering either single lives or joint lives and guaranteeing that payments will last a defined period (such as 10 years) even in the event of death of the payee.
While annuities provide tax advantages for investors who stay the course, they can also prescribe tax penalties and surrender charges for particular early withdrawals. A qualified Financial Advisor can help you decide which option is best for you in the long run.
DISCLAIMER: Guarantee depends on the claims-paying ability of the issuing insurance company and does not apply to the investment return or principal value of the separate account. Before buying an annuity, you should find out about the particular annuity you are considering. Request a prospectus from your Financial Advisor and read it carefully. The prospectus contains important information about the annuity contract, including fees and charges, investment options, death benefits and annuity payment options.
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