One of the most rewarding aspects of developing an investment plan is the benefit of learning more about what financial products are out there and which are the best investments for each circumstance. This allows investors to have some sense of control over the unknown future, and make plans for how to derive peace and wellbeing from solid financial planning.
Annuities are one such product that can provide investors with both security and great financial growth as they look towards retirement— whether in the near or distant future. Let’s discuss what an annuity is, what the structure of an annuity looks like, and why an annuity is a good choice for retirement. There are a variety of factors to consider with annuities, including types, rates, taxes, payout options, and more.
What is an Annuity?
Working people are typically used to receiving periodic paychecks. With an annuity, money is invested and then paid out: either at regular intervals or withdrawn as needed by the owner. An annuity requires a tax-deferred investment of money. This money is then paid out in an incremental fashion to the investor or a designee in regular amounts. In some cases, if the money is needed in a lump sum, it can be withdrawn. In other cases, this is not so, as we will see.
An annuity is a financial product in the form of a contract. This contract is between the investor and the insurance company. It specifies the owner of the annuity, and who the annuity will be paid out to– either the investor, or someone else. In some cases, if the recipient of the annuity passes away, a beneficiary receives the annuity.
Why Select an Annuity?
Annuities can help investors think about the future. After all, most people want to retire someday and hope to have a plan once the working life ends that allows bills to be paid while interest is made. There are several types of people who should begin thinking about annuities. For those who haven’t decided to retire yet, consider an annuity that can begin paying out immediately upon retirement. This type of annuity is called a deferred annuity.
A deferred annuity has a growth period called an accumulation phase. This phase happens while the investor is still actively adding tax-deferred money to the product. As the money grows over time, the investor can consider when he or she wishes to stop working and retire. For those who want to retire now, the best choice is an immediate annuity. This investment begins paying out right away. For an immediate annuity, the investor needs to decide whether the money should be paid out over a certain number of years, or whether it should continue paying for the rest of her or his life.
Single and Multiple Premium Annuities
There’s no way to predict the future. After all, it’s possible that retirement will only last a short while, or it’s possible to live forty years or more after the cessation of full-time employment. That’s why investors considering their options should take a look at whether they want the annuity to pay out for a particular number of years, or the rest of the person’s life. If the annuity will pay out for the duration of life, rather than when the annuity has depleted, then the investor cannot recoup the amount of money in the annuity.
A single premium immediate annuity is a product that provides for the investor for as long as that person is alive. Some may be concerned that they could outlive their retirement savings. If an investor is worried about this, he or she may wish to consider a single premium immediate annuity.
The downside of this product is that the owner cannot access the annuity in a lump sum, which is an important consideration if a large amount will be needed for large purchases or expenses. Additionally, there is no cash value to this type of annuity, which means that when the investor is deceased, no one can inherit the money.
A multiple premium annuity allows the investor to make more than one premium payment. This means that she or he can add to the annuity over time, rather than simply converting one amount of money into one annuity.
What About Interest Rates?
Saving for retirement is essential. But how can investors make the most of their money by getting the best interest rate available? After all, the larger the interest rate, the more money to be made off of the money that has been invested. Interest rates are currently low, so those looking to purchase an annuity should consider existing rates when deciding between variable and fixed annuity options. A variable annuity is a good choice if the annuity owner wants some of the initial principal to be invested at different interest rates for different risk factors. Variable annuities have subaccounts. These subaccounts can be invested more aggressively, or more conservatively, or a mix of both.
Investors should consider a variable annuity if there is some tolerance for risk, and a desire to grow part of the investment in mutual funds, stocks, or bonds.
A fixed annuity, on the other hand, has a guaranteed lowest interest rate. Some investors feel more confident with the knowledge that no matter what, their investment will payout. In this case, a fixed annuity is the best selection. Investors should note that fixed annuities may provide greater interest than the guaranteed lowest rate, and this may vary, but will not drop below the guaranteed bottom rate that is set when the product is purchased.
The interest earned on an annuity is added to the principal of the investment. This means that over time, the investor will earn interest upon the interest that has already been earned, as the principal grows.
With compound growth, the annuity pays exponentially over time. Investors can consider compound growth as an excellent reason to investigate whether an annuity is the investment for them.
What About Taxes?
Investments are always taxed. But an annuity can help investors make the most of the taxes that must be paid. Consider the fact that annuities are tax-deferred investments, so that upon payout, taxes are paid on earnings, rather than upon initial investment. This means that the total amount of money in the initial principal is larger, meaning that with interest, it will grow even larger.
Annuities, like other retirement investments, incur a tax penalty when withdrawn prior to age 59 and ½. This tax penalty takes a 10% chunk of the fund, so investors must remember this when making investments and deciding when to receive payouts.
When an investor purchases an annuity and wishes to receive funds from the product, there are several options for how payouts can occur. One choice is a periodic withdrawal. Some investors may not know when they will need liquid assets, but wish to have the option for lump-sum access to their investment on an as-needed basis.
Another option is receiving payouts is in regularly spaced payments, set in an agreed-upon timeframe. These payments may be made for a period of years, or through the lifetime of the investor, depending on the type of annuity that has been purchased.
Annuities can help investors feel better about the uncertainties that come with age. Unfortunately, none of us know how long we will live, and how much money we will need during retirement. However, family history and current health projections can be made, with an eye to the existing principal amount and expected earnings between now and retirement age. Should the investor select a single premium immediate annuity? If he or she expects to live a long time, and does not need access to the premium or wish to select a beneficiary, this may be the right choice. What about a fixed annuity? This is a solid choice if the investor is risk-averse, and is able to secure a satisfactory minimum interest rate for the product.
Annuities and Retirement
There are many factors to consider when planning for retirement. However, investors can make sound financial decisions by selecting from a variety of annuity products for their retirement needs.
There are many choices when deciding which annuity product to select, including deferred or immediate annuities, single and multiple premium annuities, variable or fixed rates, and regular payments or periodic withdrawals. Each investor will select a different combination of these factors. However, for each investor, an annuity is a solid product to consider when planning for retirement.