10 Things You Need to Know About Annuities

Annuities are commonly misunderstood. But they can be useful investment planning tools. In this article, we will go over 10 things you need to know about annuities to be in a better place to utilize them properly.

1. What is an Annuity?

An annuity is a contract between you and a life insurance company. You contribute a lump sum or sums of money in exchange for a regular income stream of distributions.

2. Is it a Good Investment to Buy an Annuity?

There are two reasons why you should purchase an annuity. First, they provide a guaranteed income stream. Second, you can fund pre-tax dollars into an annuity if you have maxed out 401k and/or IRA contributions. Additionally, there is no contribution limit for these pre-tax funds.

3. How Does an Annuity Work?

With an annuity you are paying an insurance company to take the risk on your behalf. You fund the annuity with lump sums or multiple premiums. After an annuitization period, you will begin to receive an income stream for either a fixed number of years or for the rest of your lifetime. You can receive these payments monthly, quarterly, or annually.

4. Is There a Difference Between an Annuity and Life Insurance?

While both annuities and life insurance are insured by life insurance companies, they serve different purposes. The purpose of life insurance is to provide funds to your loved ones after you pass. On the other hand, annuities are there to provide you with income during your life.

5. What Types of Annuities Are There?

There are four main types of annuities. These include:

• Immediate: These types of annuities begin to payout an income stream quickly after funding it with the initial premium.
• Deferred: A deferred annuity will pay out your income stream at a later date, usually several years in the distance.
• Variable: These annuities base their performance on underlying investments.
• Fixed Indexed: This annuity will give you a minimum guaranteed rate of return based on an index like the S&P 500.

6. How Does a Fixed Annuity Work?

A fixed annuity will pay out a guaranteed minimum rate of return. During your accumulation phase, you will receive your guaranteed interest payment through investment in high-quality fixed income investments. With these annuities the insurance company bears the risk because they guarantee the rate upon your signing the contract.

7. Variable Annuities Come with Risk

With a variable annuity your premiums are invested in subaccounts. These have varying rates of return and have no guarantee. Your accounts could perform well or could underperform and cause you to lose money. With your variable annuity you bear the risk, not the insurance company.

8. You May be Subject to Early Withdraw Penalties

Most annuities have a percentage surrender charge if you take money out before your annuitization period is complete. This usually varies between two and ten years. However, your surrender charge usually reduces each year.

9. Taxation of Annuities

Annuities are tax-deferred, which means you do not pay taxes until funds are withdrawn. If your annuity is qualified, or funded with pre-tax dollars, everything that is withdrawn will be taxable. On the other hand, if your annuity is non-qualified, or funded with post-tax dollars. Only the portion you withdraw that represents earnings is taxable. Your exclusion ratio will determine what percentage of your withdraws will be earnings and how much will be principal.

10. How Do Contract Riders Help?

Riders allow you to add additional benefits or protections. These are living riders. These provide benefits to you while you are alive. These include coverage for long term care and inflation protection. Then there are death benefits which are riders that will help protect your funds for the benefit of your beneficiaries. It is important to note that riders come with additional costs.

Purchasing Annuities

If you are looking to purchase an annuity, you can contact a licensed agent to help you navigate all of the options available.

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