Annuities as an Investment For Retirement
Annuities are not for everyone. They are generally overpriced, they limit the owner's investment choices, and they lack liquidity. We recommend annuities only for people that fit the following guidelines:
- If you plan to keep the annuity for at least 15 years, whether you make one lump sum payment or periodic payments over this time.
- If you are currently in a high tax bracket and expect to be in a lower income tax bracket in retirement
- If you do not need distributions until age 59 1/2
- If you do not have heirs (because they will have to pay ordinary income taxes on any appreciation)
- If you want a guaranteed income for life in retirement
PurchasingAnnuities can be purchased through the immediate payment, single payment deferred, or periodic payment deferred methods.
Under the immediate payment method, you give the insurance company one lump sum payment. This is an option often used by people who are close to retirement and want to get payments immediately, usually, 30 days after the payment is made.
In the single payment deferred method, you make a lump sump payment but payouts do not start until sometime in the future. This option is usually used when you have enough money to put away, have several years until retirement, and you want your money to accumulate earnings for that deferral time.
The periodic payment method allows you to put money into the annuity account periodically over a number of years. The payment amount does not have to be the same each period
Fixed AnnuitiesA fixed annuity provides you with pre-determined monthly distributions starting on a specific date. The insurance company invests the money and agrees to make the payments in the future. Investors choose fixed annuities to provide them with a steady source of future income. But your "guaranteed return" will be affected by inflation. Distributions can be increased by 3% to 5% each year (fee involved) and can last for a fixed period or for life.
Variable AnnuitiesInvestors planning for retirement often choose variable annuities. They are long-term investments that allow you to choose your portfolio, with the intention of earning more money through the stock market. The money is placed in investment options referred to as "sub accounts", which are similar to "mutual funds" or segregated "investment portfolios" that are managed by professional investment managers. The payments vary depending on the performance of the investments over time.
Equity-indexed annuityEquity-indexed annuities provide the best of both worlds, having a stable fixed account and having the opportunity to profit from stock performance. This type allows you to invest the money in a fixed account while earning additional interest based on a particular stock index. The payments are fixed for this type of annuity.
Taxes and Distributions/PaymentsAll annuities are tax-deferred, meaning that the earnings from investments in these accounts grow tax-deferred until withdrawal. Annuity earnings are tax-deferred so they cannot be withdrawn without penalty until age 59 1/2.
Distributions and withdrawals are taxed as income. If the distribution is made to the annuity-hold in a single lump sum payment, then the full amount is taxed as ordinary income for that year. If you annuitized the fixed income distributions, then part of the payment is considered principal-which won't be taxed-and part of it is considered interest earnings-which are taxed as ordinary income. Variable annuities are different, since the payments will vary according to the market value of your investments. Similarly to fixed income annuities, the principal portion of the distributions won't be taxed.
An annuity has a death benefit equivalent to the higher of the current value of the annuity or the amount you have paid into it. If the owner dies during the accumulation phase, his or her heirs will receive the accumulated amount in the annuity. This money is subject to ordinary income taxes in addition to estate taxes. If the owner purchased a term-certain annuity and the payout phase started, the beneficiary can receive payments until the end of that period.