Annuities are long-term retirement planning tools that can provide a steady, predictable source of income for life, no matter how the stock market performs or how long you live. Having an annuity as part of your overall retirement financial plan can help you:
- Add variety to your retirement savings
- Let your money grow without paying taxes right away
- Generate income through withdrawals or regular payments over time
- Have peace of mind in the face of market downturn or instability
There are many types of annuities based on risk and income potential, how you plan to pay for the annuity and how soon you want to start receiving payments.
Variable, fixed or indexed?
Your choice of annuity starts with how much risk and income potential you are comfortable with:
- A fixed annuity provides regular, guaranteed payments. Investment grows at a fixed interest rate.
- A variable annuity offers payments that vary based on the performance of underlying investments (like mutual funds). Variable annuities offer greater risk and potential reward.
- An indexed annuity’s returns are linked to a market index (like the S&P 500) with some protection against market losses and limited upside.
Whichever you choose, all annuities have two phases: accumulation and distribution. In the accumulation phase, you pay money into the annuity and let it grow tax deferred. In the distribution phase, you receive money from the annuity.
Paying into an annuity
Annuities fall into two types based on how you intend to pay for them: qualified and non-qualified. This depends on how the money you use is taxed.
- You pay for a qualified annuity with pre-tax money. This means the money has not been taxed yet. It usually comes from retirement accounts like a 401(k), traditional IRA or other job-related plans.
- You pay for a non-qualified annuity with after-tax money. This means you already paid taxes on the money. It might come from your checking account, a trust or a regular investment account.
Whether you opt for a qualified or non-qualified annuity depends on your personal financial situation and tax strategy. Your financial advisor can help you weigh the options and make a choice that supports your goals.
Taking distributions from an annuity
Annuities also vary by how soon payouts begin after purchase:
- An immediate annuity begins payments soon after you invest a lump sum. This is a common choice for retirees seeking income now.
- A deferred annuity allows your initial investment to grow tax-deferred before payments begin later on.
Distribution could be a withdrawal or annuitization, where you receive a guaranteed income stream over time.
Picking the right annuity
The kind of annuity you choose depends on whether you are saving for retirement or already using your retirement money.
You can talk with a financial professional to help decide what works best for you. Think about:
- What you want to achieve with your money
- What other savings or retirement plans you already have
- How close you are to retirement
Some annuities have extra features, like inflation protection, money for your family if you die or continued payments to your spouse. But annuities can also have fees and penalties if you take your money out early, so make sure you read and understand your plan carefully.
Find a financial professional to see if an annuity fits your financial needs.
