Annuities

Nest Egg

What is an annuity?

  • Put money into an account
  • Money grows
  • You get the money back

An annuity is a fixed amount of money paid out each year. The source can be money from an injury settlement, inheritance, lottery, jackpot, game-show win or retirement.

For retirement planning, annuities are contracts between you and an insurance provider that allow you to put money away now, have it grow, and then have it paid back to you during your retirement years.

The contract outlines the method you will follow to put in money in this savings-like account, as well as how it will be returned to you at a later date.

The two options for depositing and payout include either:

  • lump sum or
  • structured payments

Tax benefits

Regardless of the payout option you select, you don’t pay any taxes on the growth of the annuity account until withdrawal, which is why annuities are an attractive financial vehicle for saving for retirement.

Annuities can be a great source of steady income for retirement if you select the right kind.

Life insurance vs. Annuity

Annuity and life insurance policies are both contracts, but there is one major difference between them. The contract for an annuity provides you with funds upon retirement. Life insurance policies, on the other hand, only pay the person who will receive money from your policy, also known as the beneficiary, upon your death. Each of these products are offered by life insurance companies, but offered for two distinctly different purposes.

How the annuity works

With the immediate annuity option, you give the insurance company a lump sum of money and receive a series of regular payments for the remainder of your retirement years.

With the deferred annuity, investments are made into the annuity gradually over time, interest accumulates and fixed payments are made once you hit retirement.

Annuities also offer death benefits, which are sums of money paid to your beneficiary upon your death. The total amount paid may be the entire value of the annuity or just a specified minimum, depending on how you set up your policy.


Calculator: How much will you have at retirement?


Immediate vs. Deferred variable

The only way to reap the benefits offered by an annuity is to select the best one for your needs.

The selection of a variable or fixed annuity is typically dependent on if you are presently retired or if you are still in the process of saving for the retirement years. Immediate annuities are the better option for retirees who desire to have payouts immediately. Deferred variable annuities are ideal for pre-retirees who want the potential of their money increasing over time.

A breakdown of the differences

Immediate vs Deferred Variable Annuities

The catch

There are several other differences between deferred and immediate annuities. Understanding them will help you make an informed decision.

  • With a deferred annuity, you won’t be able to withdraw any money until you have reached the age of 59 ½ or you will face a 10 percent penalty on all earnings
  • You will be required to pay a surrender fee if you use the annuity prior to a certain period of time, typically around seven years
  • Earnings will be taxed as income instead of long-term capital gains rate
  • One percent per year is typically charged for the death benefit

Selecting your annuity

The best option for you will be based on your situation. Retiring doesn’t have to be hard or limited, but choosing the right annuity can impact the success of your retirement years.

Fun facts:

  • Annuities originated in Roman times when citizens would make a one-time payment in exchange for lifetime payments made once a year.
  • The word annuity is derived from the Latin word “annus”, which means year.
  • If you win the lottery, you will choose how to be paid: Cash (a one-time, lump-sum payment) or an Annuity (one immediate payment followed by 26 annual payments).
  • If you take the “Annuity” payout, for every $1 million in the jackpot, you will receive approximately $385,000 per year before taxes.

 

References

  1. http://www.megamillions.com/difference-between-cash-value-and-annuity
  2. http://www.savewealth.com/retirement/annuities/history/
  3. Source: http://wealthmarkadvisors.com/annuity-fun-facts
  4. http://www.businessinsider.com/mega-millions-annuity-versus-lump-sum-2012-3

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