What You Should Know About Retirement Annuities

Retirement annuities provide a set amount of income when you retire. Learn more about different types of retirement annuities and payment options.

One of the most important financial decisions you must make as an adult is how to prepare for retirement. There are many different retirement options to choose from. Each has different advantages and disadvantages. One of your options is a retirement annuity. An annuity is a type of insurance plan which provides a guaranteed income, based on how much you set aside. There are various types of annuity to choose from, some which last for your lifetime, while others provide payment for 10 or 20 years, starting when you hit retirement age.

Annuities have the potential to be an excellent source of retirement income, but it is not a perfect system. Before you make any decisions, it is important to understand the differences between each type of annuity as well as the various pros and cons annuities have over other retirement options.

Fixed Annuity

With a fixed annuity, you enter into a contract with an insurance company. While you are working, you pay the insurance company a set rate. This can either be in a large lump-sum or you can make smaller payments over a period of time. In exchange, when you reach retirement age, the insurance agency pays you a steady source of income, with a guaranteed interest rate. The exact amount you receive, as well as the interest rate, greatly vary depending on your individual plan.

The longer you wait to receive your payments, the more you receive from your annuity. By default, if you pass away before the annuity is paid out, the remaining payments are made to your spouse. If you do not have a spouse, you can instead have the payments sent to your family. Depending on your plan, the payments may become smaller if it is paid to your family members. There are some risks with adding too many stipulations to a fixed annuity, as it makes the negotiation process more complicated. Typically, you end up making slightly less from your annuity with each extra stipulation.

Variable Annuity

Variable annuities are much more complex than fixed annuities. With a variable annuity, you select from a number of investments. Your retirement payments are based on how successful your investments are. There is no limit to how much you put into your investments. The biggest risk is choosing to invest in the wrong areas. Ideally, your investments do well so you get a significantly larger payments when you are ready to retire.

Even if your investment does poorly, you are guaranteed to get a minimum income stream based on how much you contribute. Additionally, the money you play into a variable annuity cannot be touched by creditors, except in select states. Variable annuities have the potential to pay more than any other type of annuity, but only if you take the time to do the research and carefully plan how much to invest.

Immediate and Deferred Annuities

In addition to fixed and variable annuities, there are also immediate and deferred options. Under an immediate annuity, you pay the insurance company a large sum of money, but start collecting your payments right away. Many seniors who are close to retiring and do not have an active retirement plan choose an immediate annuity. This allows them to start collecting a regular income stream once they are ready to retire.

With a deferred annuity, you do not collect money until an agreed upon date. This allows your money the chance to grow. With a fixed annuity, you accumulate greater interest, while a variable annuity changes based on possible market gains. There may be an option to withdraw a portion of your funds early if you need emergency funds, but this carries strict penalties, based on the type of plan.

Benefits of Retirement Annuities

For many retirees, the biggest advantage retirement annuities offer over other retirement plans is security. With many other retirement plans, the payments only last for a set amount of time. If you retire early, or live for a particularly long time, you risk running out of retirement. The majority of annuities last for the rest of your lifetime. Even the limited plans often pay out for at least 20 years. With these plans, you can also transition into an immediate annuity, if you are concerned about running out of money in the future.

Another benefit is annuities are considered tax-deferred. This means you do not have to pay taxes until you start withdrawing funds. With other retirement plans, you must pay taxes even before you touch the money in your retirement account.

Risks of Retirement Annuities

Retirement annuities have the opportunity for the highest payouts of other retirement plans, but it is a much larger initial investment. Many of the best retirement annuities require you to have a large amount of wealth to initially place into your plan. This can be mitigated with a smaller payment plan, but only if you start paying into your annuity while you are younger.

While your funds are tax-deferred, once you withdraw the money from your annuity, it is considered ordinary income. Depending on your tax bracket, you may be subject to greater taxes, depending on how much you withdraw.