19 Jun 5 Elements of Annuities & More
Are you planning to establish a post-retirement income stream? Or, maybe you have come across the term “annuity” and wondering what it is about and who can benefit from an annuity.
Either way, you are in the right place, as this article is going to give a detailed insight into what annuity entails and who it is most suitable for. So let’s dive right in.
What Does an Annuity Represent?
An annuity is your insurance plan that guarantees a stable post-retirement income stream till the day you die. Sometimes, you can even add a spouse or a loved one as a beneficiary, and then they can continue to receive the annuity till they pass.
Additionally, it is a legally binding contract between you and the annuity insurance provider. As per this contract, you transfer all your longevity risk, which means you rectify the risks of running out of your money after retirement.
The insurance company takes charge of your 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 start receiving continuous and stable payments on a monthly or yearly basis.
Basics of an Annuity
The core operation of an annuity is to convert your lump sum premiums that you pay the insurance provider into an income stream. This way, you can have financial security for you in case of incapacitation or for your loved ones when you die.
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 ensures a supply of money via the process of annuitization and accumulation.
However, you can also start receiving payments as soon as a month after buying into the annuity plan. These are known as immediate annuities, where you do not need to accumulate a certain sum of money before it starts paying back.
In case you started too late on a retirement plan, such type of annuity may be an ideal and instant solution for you.
Why Else Is It Good?
Your annuity contract transfers all the financial risk associated with market volatility to the insurance company selling you the annuity. This means that no matter if the shares go down or up, you continue to receive the agreed amount of money on a monthly or yearly basis.
No matter the situation the market is in, you still receive the monthly/annual payments as agreed upon in your annuity contract.
However, there is a catch and that is that the insurance company will charge you a fee for contract riders, administrative services, and investment management. 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 be a part of your typical annuity.
These are people who can continue to receive the benefits of annuities alongside you or after you pass away. The additional rider that allows those who receive the payments after your death is known as a “death benefit rider.”
Fees and Commission
You will have to pay fees, commissions and other charges when you purchase or maintain your annuity. However, these charges may vary with the type of annuity. That said, if you are looking for the annuity with the lowest fee, then the answer to what that would be is “fixed annuity.”
Most states by law require most insurance companies to offer a “free-look” period to you as a purchaser of the annuity. This will allow you to cancel the annuity contract within a certain period of time if you do not find something that fits for yourself and your financial needs.
Moreover, if you decide to cancel the annuity contract and withdraw your monad, there will be no surrender charges during this timeframe.
The riders act as addendums to your annuity contracts. That means they 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 as per your future financial needs. You must also consider how much additional cost you will have to bear with additional riders added to your policy.
Favorable tax treatment, also known as a tax-deferred treatment, is one of the most promising components of buying an annuity. With a tax-deferred treatment, you can now accumulate all your savings without having to pay a single penny to the IRS, until you begin to withdraw the money.
Hence, it is beneficial for you no matter what your existing financial circumstances are. You will only pay taxes whenever you withdraw the money after the annuity contract matures.
Why Buy an Annuity?
If you are still wondering why you should buy an annuity contract and how it benefits you then 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 answer. That said, here some of the best benefits it can offer for your post-pension days.
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.
This is probably the most appealing factor why anyone considering retirement planning would like to purchase an annuity. You will make lump-sum or periodical payments to the insurance company for a set time period but then receive consistent income for the rest of your life.
It does not matter how long you live; the annuity insurance company will continue to pay you the amount. At times, this income may even replace the income you once earned during your working year. Think of an annuity as a channel that allows you to receive your monthly salary, even after your retirement.
Anyone 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.
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:
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 an annuity. However, it does not forbid you from withdrawing the money in case you need to, it only charges you additional fees for doing so.
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. 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 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. An independent agent who sells annuities will often do the same for you.
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.
Here are some additional tips for you in case you wish 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 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 right now.
- 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.
In the end, you should remember that annuity is a way to compliment the already in place post-retirement income plans.
So the answer to who can benefit from an annuity is – it may be a good option for you because it guarantees regular and continuous payments with potential tax benefits as well as death benefits.
That said, it would always be a wise move to seek professional advice from an experienced financial advisor and. They will help you decide if buying annuities is something you can benefit from and which ones precisely offer you the most returns.