Retirement annuities are a type of financial contract that provides a guaranteed income during retirement. You can purchase an annuity with a single lump sum payment or several installments. When you buy an annuity from a life insurance company, the insurer invests your money and pays you a monthly income. Most people purchase annuities as an alternative to a traditional pension plan.
Many annuities guarantee payments for the rest of your life, and some will even pay a death benefit or continue monthly payments to a named beneficiary after you pass away. You'll usually need to purchase a rider policy for the annuity to pay out after your death, which can drive up the cost. However, annuities with enhanced death benefits can be an effective way to secure the financial future of a dependent loved one.
There are two phases to a retirement annuity: the accumulation phase (also known as the surrender period) and the annuitization phase. During the accumulation phase, your annuity earns interest, and you may not be able to withdraw from the annuity fund without financial penalties. These annuities are known as deferred annuities. You'll start receiving regular payments when the annuitization phase begins. Bear in mind that withdrawing from a retirement annuity before the age of 59 1/2 attracts a 10% IRS penalty.
Immediate annuities allow you to begin receiving payments immediately after purchase. These annuities can be great options for people who are already retired.
How much an annuity pays out each month depends on your initial investment and the type of annuity. The most common types of annuities are:
A fixed annuity offers a guaranteed flat-rate monthly payout, so you'll always know how much money you'll receive. Fixed annuities can provide financial peace of mind during retirement because your payments won't fluctuate depending on market performance. On the other hand, they typically offer lower monthly payments than other annuity types and may not keep pace with inflation, potentially limiting your purchasing power.
Variable annuity payouts follow market trends. If the market performs well, your monthly payouts will increase. However, your payouts could also decrease if the market falls. Therefore, it's essential to plan how you'll pay for your regular expenses if your variable annuity pays less than expected.
Insurers invest indexed annuities in a market index, such as the S&P 500. Your payments reflect the index performance, which could go up or down.
The main advantage of a retirement annuity is that it provides a regular income during retirement. Many older adults worry about running out of savings, and choosing an annuity that pays out for the rest of your life can make life easier during retirement.
The money invested in an annuity grows tax-deferred. Therefore, you'll only pay tax on a fraction of your withdrawals, making annuities a relatively tax-efficient way to save.
Purchasing riders can help you create a retirement plan that fits your unique circumstances. For example, you can buy riders that prevent your income from a variable annuity falling below a specific value. Meanwhile, cost-of-living riders increase your monthly payouts to keep up with inflation.
While annuities can be great options for many retirees, there are also several drawbacks to be aware of. Annuities often come with higher fees than other retirement plans, so it's worth comparing several options to find the best fit for your situation.
The surrender periods that come with deferred annuities prevent you from accessing your funds without paying a penalty. This may not be an issue if you have enough money to see you through until retirement. However, if your circumstances change, accessing your money to pay for an unexpected event or emergency could be very expensive.
Finally, annuities may not earn as much as other investments. For many people, the security of a guaranteed monthly payout makes annuities very attractive. On the flip side, insurers may limit how much you earn from your investment.
Whether a retirement annuity is the right option for you depends on your retirement goals and your appetite for risk. If you want to secure a predictable retirement income or don't wish to monitor your investments closely, an annuity could be an excellent choice. However, if you want to achieve a competitive rate of return, you could be better off with a different investment vehicle.
For many people, an annuity is just one part of their financial plans for retirement. You can't withdraw flexibly from an annuity like you can from a regular savings account, and it's always a good idea to have some cash readily accessible for unexpected events. A financial advisor can help you choose the most suitable investment vehicles for your situation.
