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If the idea of tying your retirement savings to the ups and downs of the stock market makes you nervous, you have the option to invest in an annuity with your insurance company. Annuities provide a guaranteed monthly income for your lifetime during retirement.
Just make sure you understand how an annuity works so you can get the most out of it without compromising on your retirement goals.
An annuity is essentially a pension fund that you set up with your insurance company. You invest money through your insurance company, and when you retire, you get guaranteed monthly income payments in return.
You buy an annuity in the same way you purchase a life insurance policy — setting the amount you’ll pay in premiums based on how much you need to save in order to get the monthly income you need in retirement. You can also choose to buy an annuity with a lump sum amount like a settlement or inheritance.
Once you start paying into the annuity, the insurance company invests the money for you so that your annuity grows. Once you retire, you decide when to start your monthly payments and whether you want those to be paid for your lifetime and the life of your spouse, or whether you want to have the income for a set term.
There are three common payment terms:
Annuities are similar to other retirement accounts but have higher fees, higher taxes and more complex benefits. You’ll pay more in account management fees than most 401ks. And you might pay for your annuity with pre-tax or post-tax dollars, which affects the amount your payouts will be taxed.
For most people, an annuity offers fewer benefits than other investments. However, an annuity might be a good choice for you if you’d prefer to get a set amount in retirement and not worry about making decisions to withdraw from your other retirement accounts.
The IRS treats your monthly annuity payments as regular income and taxes them that way. But you only pay taxes on the part of your annuity that is the result of growth.
The premiums you pay into the annuity are considered income that’s already been taxed. Once the funds in your annuity account drop below the amount you paid in, you no longer have to pay taxes on your withdrawals.
For example, if you paid $50,000 in premiums into your annuity, and it’s worth $80,000 when you retire, you’ll start off treating each monthly payment as taxable income. When the fund drops below $50,000 in available funds, the payments you receive are no longer considered taxable income.
You have a few annuity options, so choose the one that works best with your retirement goals.
Benefit | Variable | Fixed | Fixed indexed |
---|---|---|---|
Guaranteed monthly income for you and your spouse | ![]() | ![]() | ![]() |
Cost-of-living adjustments (rider) | ![]() | ![]() | |
Guaranteed minimum withdrawal benefits (rider) | ![]() | ||
Guaranteed minimum accumulation benefits (rider) | ![]() | ||
Protection against market losses | ![]() | ![]() | |
Potential to leave a legacy to heirs | ![]() | ![]() | ![]() |
The riders available to you depend on the insurance company where you invest and the type of annuity you choose. Some of the more common riders on annuities include:
In addition to selecting a type of annuity, there are a couple of ways you can choose for it to be distributed:
You’ll also want to choose whether to invest one large lump sum in an annuity or to make payments over a period of time.
Whether it’s worth it for you to invest in an annuity depends on your retirement goals. If the stability of monthly payments and the security of investing with an insurance company is what you care most about, then an annuity may be a good option for you.
But if you’re looking to make a more straightforward investment to grow your wealth, the complicated terms and high fees of an annuity may not be worth it.
The security of an annuity can seem attractive at first glance, but like any insurance policy, it comes with complicated options, exclusions and fees. If you’re looking to invest, there may be better retirement fund options for you.
And if your goal is to leave a legacy for your spouse and heirs, compare annuities to other life insurance products to make sure you’re choosing the best policy for you.
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