Annuities are an insurance product that can be a beneficial addition to your retirement portfolio as long as you understand what they can and cannot accomplish. In the New York Times article Annuities: What You Need to Know by Paul Sullivan he describes them this way.
They work like an old-time corporate pension plan, paying out a regular amount of money over the course of retirement. The big difference is that amount you receive is wholly dependent on how much you put into the annuity.
In essence that is all they are – a simple investment contract created between you and an insurance company. You pay them a set amount of money – called a premium – and they promise you an income from that money.
Types of Annuities
But, let’s start with a little annuity education to help you understand what an annuity can and cannot do. In the most basic sense there are two types of annuities: deferred and immediate. A deferred annuity lets your money accumulate over time while the other pays out immediately.
Of those two overall types, though, five annuities can be purchased. They are:
1. Single premium deferred annuity: With this annuity you pay a single premium and taxes are deferred until the money is withdrawn.
2. Single premium immediate annuity: With this annuity you pay a single premium and the insurance company guarantees you an immediate fixed income for the rest of your life, and, in some cases, for a period after your death.
3. Variable annuity: With this product you get to choose from a selection of investments – basically mutual funds – and your monthly payment is based on the performance of those selections.
4. Index annuity: In this annuity your money tracks an index – for example the Standard and Poor’s 500 index — and your return is usually a percentage of how that index performed in an investment year.
5. Tax-sheltered annuity: With this product contributions are deducted from an employee’s income and, as a result, the contributions are not taxed until withdrawn. Employers can also make contributions giving an employee the added benefit of additional tax-free funds.
Investment Options: Fixed or Variable
Regardless of which of the five types you chose, your investment options boil down to either fixed or variable. Fixed annuities are similar in concept to a bank CD because upon purchase you receive a guaranteed interest rate. With a variable annuity you choose from a selection of investments and your monthly payment will be based on the performance of those selections.
Which should I buy
Investors who do not want to be concerned with the ups and downs of the market and prefer to know before retirement how much their monthly payment should go with a fixed rate annuity. Since a variable annuity is designed to boost your retirement savings — by providing you with a chance for long-term capital growth, these are best suited for people with adequate time to build capital.
To learn more about annuities and what they can do for you contact us today.