Annuities 101: Annuity Concepts for Retirement Planning


Annuities are often overlooked when developing a retirement strategy, largely because they are misunderstood. In fact, annuities have developed a bad reputation primarily because of unscrupulous insurance salespeople. The truth is that annuities can be a valuable part of your retirement plan, depending on your specific goals. To help you better understand the role of annuities in retirement planning, we offer a brief overview of annuities 101.

An annuity is a contract between you and an issuer, typically an insurance company, that requires the issuer to make payments to you either now or at some time in the future. You buy an annuity by making either a single payment or a series of scheduled payments. The annuity is paid back to you later, with interest, as one lump sum or a series of payments. If you have the means to purchase an annuity, then you can count on those annuity payments as part of your retirement income.

Part of the reason that annuities are not more popular is they are complex, as are the laws governing income taxes. For example, you do have to pay taxes on any earnings from the annuities, and there may be tax penalties if you choose to make early withdrawals.  Of course, there are exceptions, and the rules vary depending on the type of annuity.

There are many types of annuities to choose from, and there may be one that suits your retirement strategy.

Annuity Basics You Need to Know

Annuities aren’t for everyone, and you should have a basic grasp of the advantages and disadvantages of annuities before you make a decision.

There are a number of advantages to annuities:

  • They generate tax-deferred interest income; the interest is not taxable until payments are issued.
  • You can receive annuity payments for your entire lifetime, no matter how long you live.
  • When you die, the proceeds from the annuity pass from probate to your named beneficiaries, so the money is passed on to your heirs.

Of course, there are also some potential disadvantages to annuities:

  • If you have to withdraw the money earlier than planned, there may be surrender fees.
  • Most annuities are structured to incur tax penalties if you withdraw the money before you retire, or certainly before age 59½.
  • Depending on the specific type of annuity, the issuer may charge an annual maintenance fee.

Different Annuities Meet Different Needs

As with most retirement investment products, there are different types of annuities from which to choose. Here are the five most common types of annuities to consider as part of your retirement planning:

  1. Fixed annuities: A fixed annuity is the simplest type of annuity. It works as a contract with an annuity provider: You invest an amount of money, either as a lump sum or as scheduled installments, and in return, you receive interest at a fixed rate. When the annuity matures, you are guaranteed to get your principal investment plus interest repaid as predictable income.

  2. Variable annuities: As the name implies, a variable annuity is an investment that yields a variable return based on the performance of an underlying portfolio of mutual funds. If the mutual funds perform well, then the yield is higher. The advantage of variable annuities is that you get to choose the investment products in the portfolio.

  3. Fixed-index annuities: A fixed-index annuity is tied to a market index, such as the S&P 500. A fixed index annuity gives you the option of either agreeing to a fixed rate of return or investing in the market index and receiving the interest rate set by the performance of that index.

  4. Buffered annuities: A buffered annuity is a relatively new type of annuity that is a hybrid between an indexed annuity and a variable annuity. It applies a complex formula so you can invest in a portfolio of funds. However, portfolio performance can’t be guaranteed, so the terms of this type of annuity include a buffer paid by the issuing company against potential losses.

  5. Immediate annuities: An immediate annuity is designed to start paying a guaranteed income right away. Basically, you pay a lump sum into the annuity, and it immediately starts making monthly payments.

Related: Build a successful and secure retirement with iQ’s insights and  recommendations. Download this guide →

Are Annuities Right for You?

The basics offered here as part of annuities 101 should give you a basic understanding of how annuities are structured and whether they might be suitable as part of your retirement plan.

For example, annuities can be a great alternative to certificates of deposit (CDs), or you can invest in annuities in addition to CDs. If you are considering investing in an annuity, remember that they are really designed for retirement, and you should plan to invest the money so you don’t access it until you are 59½ years or older.

To determine if annuities are right for you, take a hard look at all your sources of retirement income, including retirement savings, pensions, 401(k) savings, social security, and so on. When calculating your retirement income, be sure to account for tax payments as well as an increase in the cost of living. If it looks like your monthly retirement income may fall short, an annuity may be a great way to supplement your monthly retirement funds.

Annuities aren’t right for everyone, and you need to do your research before you decide to invest. Compare different types of annuities and be sure to read and understand the terms and fine print. Take the time to educate yourself and seek expert advice before you invest.

If you aren’t sure how annuities can help you plan for the future, consult a financial expert. The financial advisors at iQ Credit Union are well versed on all types of retirement products and strategies and can help you choose the retirement investments that make the most sense for your future.

Bear in mind that your retirement strategy should change over time. As you get closer to retirement age, you want to modify your retirement plan. To get started and keep your retirement plan on track, be sure to use our Retirement Checklist, and revisit your retirement strategy regularly. As with all financial planning, you should adjust your retirement plan to accommodate changes in your income and your plans for the future.


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