Annuities are insurance company contracts. Regardless of the annuity type you choose, the fundamentals are the same: In exchange for regular payments of a guaranteed income that can aid in funding your retirement, you pay an insurance company a predetermined sum of money.
The premiums you pay and tax-deferred earnings on those premiums are designed to be a source of retirement income.
What are the most common types of annuities?
Annuities fall into six main groups: fixed and variable annuities, immediate and deferred annuities, qualified or non-qualified annuities. Which is ideal for you will depend on several factors, including your risk tolerance, your income goals, and the time frame in which you want to start receiving annuity income.
With a fixed annuity, the insurer promises the buyer a certain payment at a future time, which could be decades from now or, in the case of an immediate annuity, now. Investors can select from various subaccounts (mutual funds) when purchasing variable annuities. It offers regular payments based on the performance of subaccounts that fund the annuity’s growth.
Immediate annuities resemble life insurance policies in many ways. The investor offers the insurer a lump sum in exchange for regular income payments until death or for a certain period. Usually, it begins one to 12 months after receiving the investment, rather than paying regular premiums to an insurer that makes a lump-sum payment upon death.
Deferred annuities postpone payments until later (greater than one year). Because the insurance company is not liable for as long when income payments are delayed, they allow people to boost their income stream in later age for a lower cost.
When annuity contracts are offered through a qualified plan they are considered qualified annuities. Non-qualified annuities are bought with after-tax money, so only the investment’s earnings are subject to taxation.
How to choose between fixed and variable?
Unlike most other retirement plans, an annuity will guarantee a stream of income for your lifetime or for your lifetime and that of another person. While you may choose another payout alternative if it’s a better fit with your long-term financial plan, the assurance of income for life can help make your retirement more secure.
For example, suppose your fixed annuity pays you a specific amount each month for your lifetime.
In that case, your income may not be as vulnerable to losses in the investment markets, which may reduce your dividend or interest income or eat into your principal. Remember, though, that fixed annuity income depends on the ability of the issuing company to pay, so researching annuity company ratings before buying is crucial. Consider a variable annuity if you’re concerned that depending on a fixed income would expose you to too much inflation risk.
In that case, your lifetime income, which may increase over time, depends on the investment performance of the subaccounts, or investment funds, you select from among those offered in the contract and the company’s ability to pay claims. The risks, in this case, include the potential for a decrease in income in some periods and loss of capital.
How do immediate and deferred annuities differ from one another?
You can buy an annuity with a single premium or make payments on a regular or discretionary schedule over time. Your payment alternatives are spelled out in the contract you sign. Immediate annuities, for example, are typically single premium purchases, while payments for a deferred annuity may be made over time. Unlike individual retirement accounts (IRAs), to which you must contribute earned income, you can buy a non-qualified annuity with unearned income.
For example, if you sell a business, gain an inheritance, or receive an insurance settlement, you could use that money to buy a single premium contract. In addition, within a variable non-qualified annuity, you can move your assets among different funds during the accumulation period without owing income tax on any gains, as you can within an IRA or qualified retirement plan. There may be a fee for moving assets out of certain types of funds, though, or for transfers over the limit the contract allows.
What is the difference between a qualified and a non-qualified annuity?
If you participate in a retirement plan where you work, you may find that your employer includes a fixed or variable annuity in the menu of plan choices. When annuity contracts are offered through a qualified plan, they are considered qualified annuities. In this case, qualified means subject to the federal rules that govern how the plans are operated.
The money you contribute to a qualified annuity reduces your current taxable salary in addition to accumulating tax-deferred earnings. But you must begin taking required withdrawals no later than 70½ and take at least the required minimum each year. Alternatively — or in addition — you can buy an annuity that’s not offered through a qualified plan. In this case, the contract is a non-qualified annuity. Among the key differences are that you pay the premiums with after-tax dollars, you can contribute more than the federal limit for qualified plans, and you can postpone taking income until much later in your life if you wish.
Which type of annuity is right for you?
Each annuity kind has advantages and disadvantages. You should think about which elements of various annuity kinds will benefit your present financial condition and which will assist you in achieving your long-term financial goals. Additionally, you should contrast a variety of annuity products, examine how each suits your requirements, and consult a financial expert about how each annuity can help you achieve your goals.
You should consider the annuity payment method, the growth you want annuities to achieve, and the payout option best fits your financial goals. All in all, each of these types has a range of options that you may use to customize your annuity to your requirements, family circumstances, and risk tolerance. For instance, a fixed, deferred annuity might be the best option if you have a long way to go before retiring and don’t want to experiment with your future income. On the other hand, if you are already retired and have a significant lump sum available, you might want to consider an immediate lifetime annuity.
On the other hand, the comparatively high prices and narrow margins of annuities can deter you from buying one if you want to optimize your overall financial advantages and avoid administrative fees. Having a sound retirement plan in place is one of the most important steps you can take toward financial wellness, regardless of the options you select or if you decide to avoid an annuity entirely.
Understanding Different Types Of Annuities. Which One Is The Best? by Inna Rosputnia
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