Annuities are a form of long-term investment that offers the promise of lasting income. Essentially, when you acquire an annuity from an insurance company, they take your money and invest it in chosen ventures that are likely to bring a profit over time. After the funds have accrued value, regular payments will start being sent out to you as part of the annuitization process.
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Annuities provide a dependable flow of money in retirement which can help you manage your budget and pay essential costs. The details of the annuity will determine the length of time you receive payments – it could be for a predetermined period or, like Social Security, until the end of your life.
How does an Annuity Work?
First of all, it’s important to understand who the parties are to an annuity. Typically there are three parties but in some cases, there are four:
- The issuer – The issuer is typically an insurance company
- The annuitant – The owner or purchaser of the annuity
- The beneficiary – The beneficiary is the person or persons designated to receive any death benefit when the annuitant dies.
With almost every annuity contract, but not all, the annuitant and the owner will be the same individual.
The way your annuity works depends on the type of annuity you purchase which is generally based on your financial needs. There are four types of annuities to choose from with each differing on when you want to begin receiving payments and how you would like your contribution(s) invested:
For those nearing retirement age and seeking reliable monthly income, an immediate annuity is a great option. This type of annuity can begin providing payments within just twelve months of purchase and is typically funded via assets from a 401(k) or IRA account. Single premium immediate annuities are ideal for those ready to retire but still want the comfort of dependable income.
A deferred annuity provides a great opportunity for your investments to accumulate without taxation until retirement. This is because you won’t start receiving payments until sometime in the future, like retirement. Consequently, your money has a chance to grow and gain value over time.
With variable annuities, payments are made to the annuitant in regular intervals which depend upon the success (or lack thereof) of sub-accounts. Comparable to mutual fund organizations, these payments vary in size relative to how well the sub-accounts are performing at any given time.
For those individuals who have a very low appetite for risk, a fixed annuity could be the best fit since the interest rate on your investment is guaranteed and will not deviate for the life of your contract.
Are Annuities Taxable?
Since your annuity will grow tax-deferred, you will not have a tax liability until you begin receiving payments or take withdrawals. Additionally, your tax liability will depend on whether you purchased your annuity with pre-tax dollars or after-tax dollars.
If you purchased your annuity with pre-tax dollars, any funds you receive will be considered income and will be taxed according to the total amount of each payment received.
If, however, you purchased your annuity using after-tax dollars, you would only pay taxes on the earnings of the annuity, not the contributions.
Are there Optional Riders available for Annuities?
Most insurance companies that offer annuities offer a variety of optional riders depending on which type of annuity you purchase. Since most riders cost extra, it’s important that you discuss your needs with your insurance professional.
Here are the most common riders for your consideration:
- Guaranteed Minimum Benefit rider: Ensuring consistent financial stability during one’s lifetime, the guaranteed minimum income benefit rider provides an annuity that guarantees an individual will receive at least an agreed-upon amount.
- Guaranteed minimum accumulation benefit: For those seeking a level of security in their annuity, the minimum accumulation rider is an attractive option. It guarantees that your annuity will reach at least a predetermined value – regardless of any shifts in the market.
- Guaranteed minimum withdrawal benefit rider: This type of rider allows you to withdraw the principal incrementally each year, based on a certain percentage, until you’ve withdrawn the entire amount.
- Commuted payout rider: The commuted payout feature of an annuity contract allows for the option to receive a lump-sum withdrawal in the early stages of the agreement. This amount is usually limited to a certain proportion of the overall value of the annuity.
- Guaranteed lifetime withdrawal benefit rider: With the guaranteed lifetime withdrawal benefit rider, you can enjoy an annual income for as long as you live, not needing to exchange any of those payments for an immediate annuity.
- Enhanced earnings benefit rider: Opting for an earnings benefit rider is a savvy decision when it comes to lowering the taxes you must pay on your annuity. This rider essentially shields federal income tax on any money that is due once you have passed away. As such, it can help to minimize the amount of taxes owed.
- Long-term care rider: Without the right insurance policy or Medicaid coverage in place, the cost of access to a quality standard of care can be difficult to manage. Fortunately, a good option is available – a rider affixed to your annuity payments which can provide additional assistance towards the costs associated with a prolonged period of care.
- Disability/Unemployment rider: Should you find yourself out of work or unable to work due to a medical issue, riders for both unemployment and disabilities can boost the amount of your annuity payment for a designated time frame.
- Terminal illness rider: Should you be diagnosed with an illness that is terminal, and your life expectancy is drastically reduced, then you can benefit from the terminal illness rider which exempts any surrender charges.
- Inflation rider: Inflation is an ever-present factor to consider when investing in annuities. To protect against the negative effects of inflation, consider adding a rider that allows your annuity payments to stay on pace with rising prices.
- Return of Premium rider: The return of premium rider may be beneficial for those who want to ensure that their beneficiaries receive the principal of the annuity. This type of rider provides extra protection against not using up all annuity benefits during your lifetime. Should you pass away prior to the full payout, then any remaining principal will be returned to those named in your policy.
Does an Annuity have a Death Benefit?
In many cases, your annuity will include a death benefit for your designated beneficiary(s), if you purchase an annuity that includes a death benefit or the company will allow you to add it as a rider. Moreover, you may be allowed to add enhanced death benefits depending on the insurer. Generally, the death benefit is paid like a life insurance death benefit.
The Bottom Line
If you are considering an annuity for additional retirement planning, take a few minutes to speak with an insurance professional at LifeInsure.com to find out if an annuity would be a good fit for your retirement planning.
The experienced and reputable team at LifeInsure.com will be happy to answer any lingering questions and help you develop retirement planning solutions that will meet your needs and budget.