Saving for retirement in an annuity can help ensure you will have guaranteed income throughout your life, and many types are free from the risks of market volatility, fraud,
and outliving your savings. However, there are some tradeoffs to consider for that security and stability.

Let’s learn what an annuity is and if it’s a good investment choice for you.

What Is an Annuity?

Annuities can provide a reliable income stream to both you and your beneficiaries.

An annuity is a contract between an investor and an insurance company in which the investor pays the insurance company a lump sum or series of payments and then the insurance company invests it and guarantees fixed payments back to the investor throughout their lifetime. There are two types of annuities: immediate and deferred.

• Immediate annuities. If you’re already retired and want to start receiving payments right away, this type of annuity might be right for you. In exchange for your payment or payments, the insurance company guarantees a fixed monthly payment as long as you or your beneficiary live. With a standard immediate annuity, that fixed payout will never decrease. However, whatever money you contribute is locked into that annuity, so if you want to maintain some liquidity, you may not want to put all your funds into it. 

• Deferred annuities. If you’re saving for future retirement, you may want to consider a deferred annuity. This type of annuity starts paying out after a specified amount of time since the investor’s last payment into it. Any money you invest in a deferred annuity grows tax-deferred until it is paid out to you, the buyer, as regular income or in a lump sum at some point in the future. With this type of annuity, you can withdraw money at any time, but you may be required to pay a surrender charge of up to 7% to 10% of your account balance in the first year and gradually decreasing amounts after that until the charge disappears over six to eight years. To avoid this charge, don’t make withdrawals until that period has elapsed. Additionally, if you withdraw money from a deferred annuity before you are age 59½, you will typically pay an early withdrawal tax penalty.

What Are Your Investment Options?

Your guaranteed rate of return and payout are based on how much you contribute to the annuity; factors such as your current age, your life expectancy, and interest rates; and whether you choose a fixed, variable, or indexed option.

• Fixed annuities. These annuities will pay no less than a specified rate of interest while your account is growing, and your periodic payments will be a specified amount. Payouts are protected by state guaranty associations, which are regulated by state insurance commissioners. The level of protection varies by state.

• Variable annuities. These annuities are designed for long-term goals like early retirement. You can choose to invest your payments in a wide range of options through this type because they are considered securities. Your investment’s rate of return and your eventual periodic payment amounts will be based on the performance of those investment options. These are regulated by state insurance commissioners and the U.S. Securities and Exchange Commission (SEC). Early withdrawal can bring significant tax penalties and other charges.

• Indexed annuities. These have attributes of both fixed and variable annuities, guaranteeing a payout of no less than a specified minimum; however, that payout will still be based on changes in the stock market index and participation and cap rates set by the contract with your insurer. These are also regulated by state commissioners and the SEC.

How Can Annuities Help You Reach Your Retirement Savings Goals?

Annuities can help you boost and stabilize your retirement savings in a variety of ways. They provide regular income that will last for your lifetime – no matter how long you live – and, in some cases, is also payable to beneficiaries. They allow you to save without paying taxes on interest right away, may be adjustable for inflation, and often don’t have contribution limits. They can be a good way to supplement Social Security and pension income and can be used to both ensure regular access to your full retirement savings and supplement other investments and streams of income.

Tips for Maximizing Your Investment

Follow these three simple tips to make the most of your annuities.

1. Establish multiple annuity accounts. You could create multiple income streams by establishing both employer-sponsored and self-sponsored annuities, if that opportunity is available.
2. Contribute as much as you can. Funding pre-tax retirement accounts, like annuities and 401(k)s, as much as possible is a smart savings goal.
3. Know when to be aggressive. There may be times when you need to reduce your contributions to direct more money toward childcare, medical expenses, or other necessities. When you are not otherwise burdened, invest as much as possible to make up for these slow periods.

Essential Questions: Purchasing and Maintaining Your Annuity

Self-sponsored and employer-sponsored annuities can be purchased from insurance companies, banks, brokerage firms, and mutual fund companies. Understanding their complex contracts can be challenging, but asking the questions below of your employer or the institution you’re purchasing from will ensure you get the information
you need.

1. What is the minimum guaranteed return? This is the amount that you will be paid by your annuity no matter what. Knowing this number will allow you to calculate the minimum amount of income you’ll have each year
   of retirement.
2. What are the initial and annual fees? Fees can typically be paid annually or upfront, depending on the type purchased. Knowing what you’ll owe will allow you to comparison shop to find the best deal.
3. What are the surrender fees if you want to withdraw early? Understanding the surrender fee will help you determine how certain actions can devalue your account.
4. What waivers are available if you need your money right away? If you experience an unexpected event or emergency that requires immediate funds, like a medical condition or need for a nursing home, waivers are often available. Knowing what’s allowed with your annuity can help you plan for the unexpected.

Best Practices for Annuity Planning

Annuities can provide a reliable income stream to both you and your beneficiaries, but you need to take certain steps to ensure they function the way you need them to.

1. Select primary, multiple, and contingent beneficiaries. Like other investments, most annuities can be passed to your heirs in the event of your death. Update your beneficiaries when life changes like birth, marriage, divorce, and death affect your plans, and select a contingent beneficiary who can inherit your annuity if your primary beneficiary precedes you in death.
2. Understand what’s involved in a transfer. If you need to transfer your annuity to another company, you can avoid paying taxes or early withdrawal fees by completing a 1035 exchange. If you transfer your annuity to another person, you may incur a gift tax. The Transfer Payout Annuity (TPA) is an option for some account balances as a rollover or cash withdrawal.
3. Keep your rollover tax-free. Especially in the public sector, employer-sponsored retirement plans are usually variable annuities, like 457 or 403(b) plans. You can roll your tax-sheltered annuity over to a traditional IRA tax-free when you change jobs.

Make a Plan for Your Ideal Retirement

Before you decide to buy an annuity or invest in any form, make sure you have a clear picture of your retirement savings goals and what you need to do to stay on track. Talk to your financial advisor for help creating a plan that maximizes your potential for stable savings.

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