What are the types of annuities?
There are three main types of annuities: fixed, variable, and indexed, and there are two types of funding phases: immediate and deferred.
These are the three main types of annuities:
- Fixed annuities. Returns on the annuity are paid on a guaranteed, steady interest rate.
- Variable annuities. Returns are tied to underlying investment options, such as mutual funds, whose performance impacts your payouts.
- Indexed annuities. Returns are tied to a market index, such as the S&P 500, and have a guaranteed minimum floor so that you can't lose principal.
These are the two methods of funding:
- Immediate annuity. You pay money to the insurer upon retirement or close to retirement. The insurance company then pays you.
- Deferred annuity. The money is invested and accumulates until you're ready to take withdrawals during retirement.
Annuities build up money tax-deferred and they don't have IRS investment limits. They can be attractive for people looking for additional ways to save for retirement. Many financial experts recommend people consider annuities only after they have maxed out tax-advantaged contributions to other retirement plans.
How do annuities work?
An annuity works in two phases: accumulation and distribution. In the accumulation phase, you choose a type of annuity and then make either a lump-sum payment or a series of payments. With an immediate annuity, the distribution phase begins quickly; you will see funds paid out within a short timeframe, sometimes as little as a month. With a deferred annuity, the money accumulates for a set time period before you start receiving payments.
Payments from an annuity can last for a fixed period or for the rest of your life, depending on the terms of the contract.
Pros and cons of annuities
Annuities provide a steady, lifetime income stream and tax-deferred growth, and may provide a death benefit to your chosen beneficiaries. However, they can have high fees, limited withdrawal options, and rely on the financial health of the backing insurance company.
Pros:
- Steady retirement income
- During accumulation, funds grow tax-deferred
- Death benefit option
Cons:
- High fees that include administrative costs and surrender charges
- Limited access to withdrawals. with tax penalties of 10% if you withdraw before age 59½.
- Dependent on the financial stability of the insurance company backing the contract.
