Generally, an annuity works like this: You purchase the annuity, either in a lump sum or a series of payments. In return, the annuity will make payments to you at a future date or series of dates.
Annuities come in many different “flavors” – each of which is designed to help you achieve specific financial goals. They can work to build retirement savings, supplement other forms of retirement funding, or both.
The different varieties of annuities can also be bewildering. Depending on individual circumstances, many people turn to a financial professional to help them navigate the choices.
Traditional deferred annuities
“Traditional” deferred annuities are the kinds of annuities with which most people are familiar. They are designed to help you accumulate assets on a tax-deferred basis as you save for long-term goals like retirement. Let’s look at two basic examples of traditional deferred annuities: “fixed” and “variable”.
Deferred fixed annuities are “fixed” because they offer fixed interest rates. They are “deferred” because they require a waiting period before annuity payments can begin. During the deferral period, money in your contract is credited with a fixed rate of interest and grows at a steady pace.
Because you don’t pay current income taxes on the earnings in your contract until you withdraw it, more of your money remains available to benefit from that steady growth. Fixed deferred annuities also offer annuity income options that can provide guaranteed income for life or a certain period of time (like 10 or 20 years). This type of annuity typically includes a withdrawal provision that allows you to access the money in your contract. It’s important to understand, however, that withdrawals may be subject to surrender charges, income tax, and even tax penalties.
A fixed deferred annuity may be worth considering if you are looking for a conservative way to grow a portion of your assets and avoid market volatility. It may not be the best choice if you prefer greater growth potential (and don’t mind taking on the risk that goes with it) or if you need income that starts right away.
Variable deferred annuities – Unlike fixed annuities, variable annuities are built to provide financial market exposure. Variable annuities generally offer a broad range of investment options – from more conservative fixed accounts to riskier growth options. Like a fixed deferred annuity, the money in a variable annuity also benefits from tax deferral. You don’t pay current taxes on earnings in your contract until you withdraw them – which means more of your money remains available to benefit from potential growth. A variable annuity also offers a variety of options when it comes to receiving income – including lifetime income options.
Of course, greater growth potential involves more risk. A variable annuity can increase or decrease in value, depending on how financial markets perform. When considering a variable annuity, it’s essential to understand how the annuity works, including associated fees and expenses as well as the surrender charges, income tax and tax penalties that typically apply to deferred annuities. Just as important, you should have a clear sense of your financial goals and tolerance for risk. A financial professional can help you make an informed decision on whether a variable annuity is right for you.
In next blogpost, we will discuss Income Annuities.