Who Can Benefit from an Annuity?
Are you planning to establish a post-retirement income stream or, maybe you have come across the term “annuity” and are wondering what it is about and who might benefit from an annuity.
Either way, you are in the right place, as we will provide you with a detailed insight into what an annuity entails and who it is most suitable for. So let us dive right in.
What an Annuity Represents
An annuity is an insurance plan that guarantees a stable post-retirement income stream until the day you die or a set number of years. Often times, you can even add a spouse or a loved one on as a beneficiary. They can then continue to receive the annuity after you pass.
An annuity is also a legally binding contract between you and your annuity insurance provider. As per this contract, you transfer all your longevity risk, which simply means you rectify the risks of running out of your money after retirement.
The insurance company takes charge of the money that you accumulate for a certain predetermined period of time. These payments that you handover to the insurance company are also known as monthly premiums.
Once the insurance policy matures, you can then start receiving continuous and stable payments on a monthly or yearly basis.
Basics of Annuity
The core operation of an annuity is to convert your lump sum premiums paid to the insurance providers into an income stream. This way, you as well as your loved ones can have financial security in case of incapacitation or your passing.
Suppose you are a retiree who may require more than simple investment savings and social security money to take care of your post-retirement needs. An annuity design can ensure a supply of income for you via the process of annuitization and accumulation.
Immediate Annuity
While typically the goal is to let this income stream mature, you can also start receiving payments as soon as one month after buying into an annuity plan. These types of annuities are known as immediate annuities. With immediate annuities, you do not need to accumulate a certain lump sum of money before it starts paying you back.
For those who had a late start on retirement planning, this type of annuity may be an ideal and instant solution.
Other Benefits
Your annuity contract also transfers all financial risks associated with market volatility to the insurance companies. This means that regardless of if your shares go down or up, you would continue to receive your predetermined payments on a monthly or yearly basis.
Meaning no matter the case, this money will remain steady up until your last breath, and even after. However, there may be a catch. Some insurance companies will charge you a fee for contract riders, administrative services, and investment management.
Additionally, you should always remember that most annuities come with a surrender period. This refers to a time frame in which you cannot withdraw any payments accumulated in the annuity contract. However, if you decide to withdraw any amount of money prior to your surrender time is over, you must pay a surrender charge or additional penalties.
In the case of buying an indexed annuity, there are also chances that your insurance company may apply spreads, participation rates, and caps.
5 Elements of Annuities
Here are five essential elements that can make up your typical annuity.
Beneficiaries
These are the people who may continue to receive the benefits of your annuity alongside you or after you pass away. The payments after your death are “death benefit riders” and is giving to your beneficiaries.
Fees and Commission
You will have to pay fees, commission, and other charges when you purchase or maintain your annuity. However, these charges may vary with the type of annuity that is chosen. That being said, if you are looking for the annuity with the lowest fee, then the answer is “fixed annuity.”
Free-Look Period
Most states require by law that the insurance companies offer a free-look period to all purchasers of an annuity. This will allow you to cancel the annuity contract within a certain period of time. Moreover, if you decide to cancel the annuity contract and withdraw your cash, there will be no surrender charges during this timeframe.
Riders
Riders can act as addendums to your annuity contracts. This means you can customize your existing annuity contract and add additional sources of return on investment. It is crucial to know what type of riders you can add on. You must also consider how much additional cost you will want to incur.
Taxation
Favorable tax treatment, also known as a tax-deferred treatment, is one of the most promising components of buying an annuity. You can now accumulate all your savings without having to pay a single penny to the IRS.
Hence, why it is beneficial for you no matter what your existing financial circumstances may be. You will only pay taxes whenever you withdraw the money after the annuity contract matures.
Why Buy Annuity?
If you are still wondering why one might purchase an annuity contract, here are some of the fundamental reasons why you should purchase a post-retirement annuity plan:
- It will protect your principal investment amount. No matter how the market performs, it will not affect your principal amount, and you can withdraw it anytime.
- It offers protection to your investment on a long-term basis
- It offers tax-deferred investment growth or return on investment
- You never have to worry about the inflation rate as the annuity auto-adjusts any future inflation rate, and you continue to receive a stable income.
- It offers you the chance of an estate distribution that is probate-free
- It also offers death benefits to your spouse, heirs, or beneficiaries
What Benefits You Can Enjoy
If you are looking for a pathway to create a predictable income stream to fund your retirement days, then an annuity is the best solution. Here are just some of the best benefits it can offer for your post-pension days.
Guaranteed Growth
An annuity will offer you a guaranteed return on your investments. You can buy a fixed annuity with a pre-determined interest rate and receive annual payments from the annuity insurance provider. However, this amount may stay the same or change over time.
Your annuity may also offer hypothetical growth, i.e., your account balance does not increase literally. The balance in your account increases hypothetically, and you can take the amount out of your annuity after a certain time frame.
This comes with an added security that even if your actual account balance falls to zero, you will still be able to make regular withdrawals potentially.
Lifetime Money
The lifetime money aspect is probably the most appealing factor of an annuity. This is often why anyone considering retirement planning might purchase an annuity. How it works is, you would make lump-sum or periodical payments to the insurance company for a set time period. In return you would then receive consistent income for the rest of your life, after retirement.
It does not matter how long you live; the annuity insurance company will continue to pay you that amount. At times, this income may even replace the income you once earned during your working years. Think of an annuity as a channel that allows you to receive your monthly salary, even after your retirement.
Looking For Tax-Deferred Investment
Almost all income, interest, and growth within your annuity come with a tax-deferred clause. That means you do not have to report it to IRS every year. You will only pay a one-time income tax whenever you withdraw your funds after your annuity matures. Think of it as paying income tax on your salary every month.
That said, if you already have a retirement plan with tax-deferred growth benefits such as 401(K), 401(B), or IRA, then tax-deferral in your annuity will not do much for you, unless you’re regularly maxing out the amount you can put into those other accounts.
However, if you happen to fall in a high-income taxation bracket, then purchasing an annuity may help you make the most of the tax-deferral benefit.
Who Can Benefit from an Annuity
If you want to be sure that you fall in the category of retirees who can benefit from an annuity, here are some additional points to consider.
- Maxed out on Other Retirement Plans
If you have already maxed out on 401(K) and IRA plans and all other options for tax-advantaged post-retirement investment plans – then you should definitely consider purchasing an annuity.
- Additional Money to Set Aside
In case you have additional savings or money that you wish to set aside from the traditional retirement plans, then annuity plans with a tax-deferred growth guarantee are an ideal choice for you.
This recommendation is more potent if you are someone who falls in the tax bracket of a high-income individual, businessman, or entrepreneur.
- You Do Not Need Immediate Returns
Are you someone who is not looking for an immediate return on investments? Additionally, would you not mind putting the money away for an extended duration? Then it would be best if you looked into the annuity. However, it does not forbid you from withdrawing the money in case you need to.
For instance, you wish to withdraw any sum of money within the first 5 to 7 years of purchasing the annuity. In this case, you will typically have to pay an early withdrawal penalty or surrender charges of up to 7 percent of your principal investment amount or even more.
Moreover, an annuity will also charge you for other services. Moreover, the initial commission may cost you up to 10 percent of your principal investment amount. In case you are the owner of a variable annuity with an option for ongoing investment management, this may cost you up to 2 to 3 percent on an annual basis.
- If you have a Financial Advisor’s Assistance
With all their components, calculations, taxations, and fees, the annuities become a complicated financial affair. Therefore, if you already have the assistance of a financial advisor, buying an annuity becomes an easy option for you.
The financial advisor will not only explain all the positive features and risks involved with each annuity type. Plus, you will be able to ask any questions and concerns you may have regarding this post-retirement income channel.
- Someone Looking for Supplement Income Stream
Are you ok with your current retirement plans but would love to add an additional income stream? Then annuity can offer you a more than comfortable lifestyle after your working years are behind you.
Additional Tips
Here are some additional tips for you in the case that you plan to buy an annuity retirement plan.
- Before you invest in an annuity, always compare the fee structure with your regular no-load mutual funds. The latter, no surrender charge, sales commission and only impose penalties less than 0.5 percent and 1.5 percent on index funds and actively managed funds, respectively. Therefore, determine which will serve your current financial circumstances and future investment goals.
- It is of significance to remember that all your earnings from an annuity will be subject to tax when making withdrawals. No matter how much you withdraw and at what intervals, you will have to pay the income tax applicable at the time of withdrawal.
- Avoid purchasing an annuity when you are too young because, by the time you retire, the income tax will be way higher than what it is at the time of paying the policy.
- Avoid buying too late because most companies will be reluctant to sell after you reach a certain age.
- Buy when the annuity interest rates are higher because this will help you gain more income on your investment amount.
- Only purchase the option and pay for the riders that you really need.
- Do not pass up the investment options just to increase your chances of getting higher returns. You will have to pay for each add-on, and you may end up paying more than what you will get in return.
- Do not put all your eggs in one basket, i.e., do not invest all your savings into an annuity plan only. Use it as an additional income stream for your post-retirement days.
The Takeaways
You should note that, an annuity is a great way to compliment your already in place post-retirement income plans.
So the answer to who can benefit from an annuity is – anyone. It may be a good option for some because it guarantees regular and continuous payments with potential tax benefits as well as death benefits.
With that being said, it is always a wise move to seek professional advice from an experienced agent. They can help you decide if purchasing an annuity is something you can benefit from. An agent can also help you determine precisely which annuity offers can offer you the highest returns.