Consumers have more and more financial tools at their disposal to help them save for their future, but one of the least known is an annuity. An annuity is a contract between you and the annuity provider, usually an insurance company.
Some annuities will allow a one-time premium payment, while others allow multiple payments over time. But with all annuities, you will give the provider some of your savings, and in return, they will provide you with certain guarantees about your investment.
More and more consumer-friendly innovations are being applied to annuities, but there are still four main types to be familiar with:
Depending on what type of annuity you purchase, access to your investment may be limited during the contract period. Still, more often than not, annuities offer more liquidity than other fixed products. And while an allowance can be purchased with either pre-tax (qualified) or after-tax (non-qualified) money, all earnings within an annuity will grow tax-deferred, meaning you won’t pay taxes on any income growth until you withdraw money.
Here are some other benefits that come with owning an annuity:
Earnings in many investment options, such as stocks or mutual funds, are taxed yearly. Annuities offer investors something different -- the ability to defer taxes on earnings within the annuity until you take money out. And unlike your 401(k) or IRA, there are no limits to how much money you can invest in an annuity each year. If you purchase a variable annuity, you’ll be able to transfer money between different investment funds tax-free.
Like CDs, fixed annuities will offer you a guaranteed rate of return on your investment for a fixed period of time, such as a 3% guaranteed interest rate over five years. Once that contract ends, you can renew the contract, possibly at a different rate, or withdraw your money. Fixed annuities also offer more generous early withdrawal options than CDs.
Other annuities, such as indexed, offer investors peace of mind by providing an investment floor. This means your original premium is protected, and even if the stock market declines and you lose money in the annuity, you’ll never lose more than your original investment. Because they’re protecting your losses with a floor, the annuity provider may cap earnings on the upside, meaning your gains may be limited if the stock market surges. But for many consumers, this is an attractive trade off – potential growth, but no risk of loss. Some variable annuities can also be structured to limit losses in a down market.
Income annuities, whether you structure them to begin payments immediately or defer them until later in life, offer you a chance to create a stream of guaranteed income. These can be structured for a set period of time or the rest of your life. For example, if you want to retire early, say at 60, you can purchase an immediate annuity with a 5-year payout. This will provide income until you can claim Social Security benefits at 65. Or, if you’re 55 now and plan to retire in 10 years, you can purchase a deferred annuity that begins payments when you turn 65. Income annuities can be structured to create a guaranteed income for life when you retire. Still, the amount of that income will depend on how much money you put into the annuity and other factors such as gender, age at purchase, and where you live.
One misconception about annuities is that if you die, money within the contract reverts to the issuer, and you can’t pass it on to your beneficiaries. While this used to be true of some income annuities, they have evolved to meet consumers' demands. Depending on how they are structured, an income annuity can now make the remaining payouts to your beneficiary(ies) or provide a lump sum payment based on any unused premium.
Money in fixed annuities will be inherited by whomever you name as your beneficiary. And variable annuities offer a unique opportunity. Most offer a death benefit option that’s not subject to underwriting. So if you would no longer qualify for life insurance, a variable annuity with the death benefit option could offer you the opportunity to provide a financial legacy to loved ones or a favorite charity.
And a bonus advantage? Proceeds from annuities will pass to your heirs outside of probate, not subject to a will so that beneficiaries will receive their inheritance directly and without delay.
Annuities continue to evolve, and more and more investors are finding they offer a useful solution within their financial portfolio. If you’d like to learn more, give Sea Mountain Insurance a call or contact us for more information. We’re happy to answer your questions.
