Annuity Basics Everyone Should Know
What if you had a way to put some money aside, have it grow in value, and then be able to receive a guaranteed income that would last through your retirement? Buying the right kind of annuity may be that way, ensuring that you will receive a steady income in retirement and never run out of money for the rest of your life.
What are annuities?
An annuity is a contractual agreement between a buyer (owner) and an insurance company (seller). Annuities are used to save for retirement or to convert the savings, or current wealth into a stream of income at a future date. To generate an income stream an individual purchases an annuity and the insurance company makes a promise to make regular payments (income) that begin on a specific date in the future. Annuities can be purchased by anyone, but they are primarily used by people who wish to generate a guaranteed stream of income during retirement.
You can buy a number of different types of annuities. In general, an annuity can be categorized as a single-premium deferred annuity, an indexed annuity, an immediate annuity, or a variable annuity. Within those categories, annuities can have several different features. The most common of these annuity products are the single-premium deferred annuity and the immediate annuity.
Single-premium deferred annuity
With this type of annuity, you make a single premium payment and delay the date at which time you can start to receive a stream of income. During the deferral period, your money grows tax-deferred. The amount of your payout is determined by several factors including the given interest rate, the time between purchase and the day you start receiving monthly payouts, and your life expectancy.
With an immediate annuity, there is no deferral period. You pay a lump sum (single premium) to purchase this product and your stream of income begins promptly after that payment. Usually, your payout starts about 30 days after your purchase. When you receive income, if the annuity was purchased with non-qualified funds, part of your payout is considered return of principal and is not taxed.
Insurance companies assume risk when they guarantee your future payments. Those risks include such things as interest rate risk, market risk, and the risk of you living longer than your life expectancy. In return for assuming such risks, the contract may include expenses and fees, including surrender fees.
When you purchase an annuity, the guaranteed elements of the annuity are backed by the financial strength and claims paying ability of the issuing insurer. Annuities are regulated by each individual state’s Department of Insurance. Annuities aren't guaranteed by the FDIC or any other federal government agency but there are strict capital and reserve requirements that necessitate insurance companies to hold one dollar in reserve for every dollar in benefits owed. Annuity companies typically invest in very conservative financial instruments like high-quality corporate bonds and U.S. government bonds.
Length of Payout
Buy an annuity and you can elect to have income for life. Once your payout begins, you will continue to receive regular installments as long as you live. Some annuities (joint) can be structured to provide income not only for your lifetime, but also for your surviving spouse’s lifetime.
The best way to buy annuities
Annuities can be complicated and confusing to understand. Using the services of an agency that has trained professionals to guide you through the process is preferable to trying to go it alone. An agent can help you compare the various types of annuities offered by different insurance companies and inform you on which contracts and riders are available in your state. With so many annuity products on the market being offered by a wide range of insurance companies, it may benefit you to work with an independent agent that represents more than just one insurance company. Using an independent agent that has access to the annuity products offered by many different companies, and is experienced in all of the complexities of annuities, can help ensure that you get the best annuity for your situation. Purchasing an annuity is a big financial decision so you want to be sure that you are buying the right annuity that is appropriate for your objectives.