Annuities 101
Learn how annuities can provide guaranteed income, tax‑deferred growth and protection for your retirement.
What Are Annuities?
An annuity is a contract between you and an insurance company that can provide a stream of payments during retirement. People typically purchase annuities to manage income in retirement. They offer periodic payments for a specified time (often for life), a death benefit for your beneficiary if you die before payments begin, and tax‑deferred growth on your contributions.
Why Buy Annuities?
Guaranteed Income: Provides regular payments for a set period or for the rest of your life.
Death Benefit: Pays a benefit to your named beneficiary if you die before receiving income.
Tax‑Deferred Growth: Earnings grow tax‑deferred until you withdraw them.
Types of Annuities
Three basic annuity structures and how they work
Fixed Annuity
Offers a guaranteed minimum interest rate and a fixed amount of periodic payments. Fixed annuities are regulated by state insurance commissioners.
- Stable, predictable income
- Subject to insurer’s financial strength
Variable Annuity
Allows you to invest in mutual fund‑like portfolios; the value of your annuity and the size of your payments will vary based on investment performance. Regulated by the SEC.
- Potential for higher returns
- Market risk can reduce payments
- Designed for long‑term goals; early withdrawal may incur penalties
Indexed Annuity
Credits returns based on the performance of a stock market index such as the S&P 500. Offers the potential for higher earnings than fixed annuities with some downside protection.
- Balance of risk and reward
- Participation rates and caps limit returns
How Annuities Work
Understanding the accumulation and payout phases
Accumulation Phase
During this phase you make payments into the annuity, which may be invested in various options. Variable annuities let you split contributions among investment portfolios and may include a fixed interest account.
Payout Phase
Once payments begin, you receive your purchase payments back along with any investment earnings. You can choose a lump sum or periodic payments, typically monthly.
Fees & Charges
Understand the costs before you invest
Common Fees
- Mortality and expense risk charge: Typically around 1.25 % of your account value to compensate the insurer for risks under the contract.
- Administrative fees: Flat annual fees or a percentage of your account value to cover record‑keeping and other expenses.
- Underlying fund expenses: Fees charged by the mutual funds underlying variable annuities.
- Additional feature fees: Charges for riders such as guaranteed minimum income benefits or long‑term care coverage.
- Early withdrawal penalties: Withdrawing funds before age 59½ may incur a 10 % IRS penalty on top of taxes owed.
Fraud Prevention & Tips
- Variable annuities are regulated as securities. Confirm that any broker or adviser selling annuities is properly registered.
- Read and understand your annuity contract, including all fees and surrender charges.
- If you invest through a tax‑advantaged plan such as a 401(k) or IRA, a variable annuity provides no extra tax benefits.
Plan Your Retirement Income
Annuities can provide guaranteed income and tax advantages, but they come with costs and risks. By understanding the different types and fees, you can decide whether an annuity fits into your retirement strategy.