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Retirement Planning
Annuities as an Investment For Retirement
by InvestorGuide Staff (Write for us!)
(Click on a link within the article to get a definition of that word)
As a retirement-planning tool, an annuity is a contract between you and
an insurancecompany for guaranteed interest and incomepayments. During the accumulationphase, the investor makes payments to the issuing company, which will eventually be given back to the investor with added interest during the distribution phase, or annuity period. The accumulation phase can last from as long as one day to several decades, depending on the size and frequency of payments. While most investors make payments over long periods of time, an investor could choose to make a singlelump sum payment; both methods will result in future payments that include interest. The insurance company will then take the contributions, whether it was a lump sumpayment or many dispersed payments, and invest it accordingly. The distribution phase begins when contributions stop and you start receiving annuity payments, this is when the annuity is said to be annuitizing. Distributions can be made to you as a lump sum or through regular distributions over time. Once contributions are being distributed, you cannot withdraw any of the funds, and you receive funds according to the distribution schedule agreed upon. Annuities also provide taxbenefits to investors by deferring the taxespaid on the earned interest.
Annuities are not for everyone. They are generally overpriced, they limit the owner's investmentchoices, 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 want a guaranteed income for life in retirement
Purchasing
Annuities 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
A 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.
Equity-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/Payments
All 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 benefitequivalent to the higher of the currentvalue of the annuity or the amount you have paid into it. If the ownerdies 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.
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