If annuities are part of your retirement plan, then you're in good company. In a published study, The Differences They Make: An Advisor, an Annuity or a Formal Plan in a Retiree's Life (2018), by the LIMRA Secure Retirement Institute found 73 percent of retirees who own an annuity believe they will be able to live the retirement lifestyle they want.
How annuities work
An annuity is a contract between you and an insurance company. You make an investment in the annuity, and in return the insurance company agrees to make a series of payments(or a lump- sum) beginning on a future date. The income you receive from an annuity can be paid out for a specified period or even for the rest of your life.
Retirement planning using annuities
Annuities are often used as a retirement planning tool primarily because they can allow you to turn a lump sum of money into a steady income stream for a set number of years, or even the rest of your life. Common uses for annuities in retirement planning may include, among other things, accumulating assets, supplementing Social Security or a pension, and receiving income for life.
Retirement advantages of annuities
One of the greatest advantages of using annuities for retirement planning is that you can put away larger amounts of cash and defer paying taxes. Just like your 401(k) or IRA, as long as you leave your earnings alone, the growth on annuities is tax-free until funds are withdrawn. However, unlike other tax-deferred retirement accounts, there are no annual contribution limits. Not only does this allow you to save more, it is useful for individuals who are near retirement and need to catch up.
Types of annuities used for retirement include:
- Fixed annuity
A fixed annuity gives you the promise of fixed interest payments over a specified period of time. You agree to deposit a lump sum of money or series of payments and the insurance company agrees to pay you a guaranteed rate of interest that compounds on a tax-deferred basis.
- Variable annuity
A variable annuity (VA) puts your money in investments that you select from a list made available by the issuing insurance company. Most often, those investments are a variety of portfolios providing you with options that may include both stocks and bonds. As an additional benefit, some VAs offer an enhanced death benefit that guarantees your beneficiary won't receive less than your original investment (minus withdrawals) - no matter how the funds perform. However, all guarantees are dependent upon the claims-paying ability of the issuing insurance company.
- Indexed annuity
The indexed annuity is a type of fixed annuity that calculates interest payments based on upward and downward movements in common indexes such as the S&P 500 Index. You are provided the opportunity to enjoy the benefits of positive upturns in the index (subject to a cap) with a limit to your downside risk. However, you would not be directly invested in the stock market or index.
The combination of tax deferral and the ability to establish guaranteed income can make annuities an effective part of a retirement plan while protecting retirees from the possibility of outliving their income.