Key Takeaways
- Annuities are a way of saving, investing, and distributing.
- There are many different types of annuities.
- The older you are when you start taking money out of an annuity, the more you’ll get back.
When you hear the word “annuity,” an image of someone old, such as Father Time, might come to mind. Annuities just sound like something your grandparents or other older relatives might have owned. You may not have heard a lot about them, but annuities are actually a very good instrument.
Annuities are issued by insurance companies in the United States. The insurance companies are authorized state-by-state to issue them and there may be two parts to an annuity: the accumulation phase and the distribution phase.
You may start by putting money into an annuity and it will accumulate at some return over a period of time. After that amount of time, you can select to turn it on to distribute your money. (Note that there are usually penalties for taking the money out before age 59 ½.)
During the accumulation period, you can grow the annuity like you’d grow an IRA or a 401(k). Annuities grow tax deferred, under a special tax law relative to them. When you take the money out, if it’s a post-1982 annuity, you take out the earnings first and you pay ordinary income tax on this, meaning the highest level of tax.
You may place a lump sum into an immediate annuity, which means you can select a payment over a period of years, usually your lifetime. The older you are when the annuity is issued may result in more money distributed, usually monthly, from the insurance company. You’re getting back your earnings and a lot of your principal because the annuity is based on your life expectancy, making payments to you for the rest of your life.
There are many ways to structure an annuity. You can base it on yourself and your spouse, making it a joint annuity. You can make it a joint annuity and have it be 50% payable, or you can make it a 100% annuity on your life only. There are many different choices, types of payment streams over different periods, and different types of guarantees.
You can accumulate annuities as either fixed or variable. With fixed annuities, the insurance company will guarantee a certain rate of return. With variable annuities, you pick different investments in mutual funds and exchange-traded funds, much like you would with an IRA or 401(k) – and it’ll go up and down with the market.
There are many more types of insurance packages and options to consider with annuities, beyond what’s outlined here. They may be something to add for your retirement, down the road, and they’re not just for Old Father Time. Until next time, enjoy.
Gary
If you’d like to read more on this topic, here is one of Gary’s previous posts that you might enjoy:
