Annuities 101 - How to Decipher Your Options


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April 19, 2017

Wondering if an annuity could help you accomplish your retirement income goals? Annuities sometimes get a bad rap – usually due to misinformation. We’re here to dispel the myths! Below, we cover how annuities work, the different types to consider, and how an annuity could potentially fit into your retirement plan.

Five simple annuity truths

There are five things to know about annuities:

1.An annuity is a contract between the annuitant and an insurance company. It is an insurance product - not an investment.

2.The annuitant contributes to the annuity for a specified period; the insurance company distributes the accumulated contributions plus earnings to the annuitant for a specified time.

3.An annuity can be a source of guaranteed lifetime income.

4.Annuities benefit from favorable tax treatment; earnings on contributions are usually not taxed until distributed.

5.There are many types of annuity products. A financial professional experienced with annuity products is your best resource to decide which type of annuity is right for you.

That said, let’s take a closer look at some annuity variables.

Annuity contributions

Contributions can be made over a period of time as in a flexible annuity or as a single, lump-sum deposit in a single-premium annuity. An annuity product can be tax-qualified and allow pre-tax contributions. The IRS imposes an annual contribution maximum on qualified annuity plans. Non-qualified plans have no contribution maximums.

During the contribution phase, the annuity value will grow from a combination of additional contributions, earned interest and possibly other earnings, depending on the type of annuity product.

Annuity distributions

The distribution period can begin immediately. In the case of a single premium immediate annuity, the annuitant deposits a large lump-sum and begins to receive distributions immediately. On the other end of the continuum, is a longevity annuity. Designed to ensure income in the later years of retirement, the contribution is a lump sum made before or early in retirement and distribution is intentionally delayed until much later, perhaps to age 85 or 90. Most other types of annuities begin distributions when the annuitant choses. Contributions end when distributions begin.

Annuity products

Besides the longevity annuity mentioned earlier, annuity products can be fixed, variable, or indexed. Broadly speaking, the difference is in how the annuity value changes. A fixed annuity earns interest based on the interest rate declared by the insurance company; the interest crediting rate may never be less than the guaranteed minimum interest rate. The insurance company may increase the interest crediting rate depending on the economic environment but must always credit interest at least at the guaranteed rate.

Variable annuities were designed to take advantage of the equity markets. The annuitant actively selects, from a list of investments, how contributions are invested. The upside potential is greater than a fixed annuity but it comes with risks similar to equity markets. Variable annuities also introduced innovative riders like lifetime inflation protection. These products may also come with a higher price tag driven in part by the costs of investing.

The third and newest product is an indexed equity annuity. Earnings are based on the performance of indexed funds chosen by the annuitant. They provide more earning potential than fixed annuities with a safety net for market losses and without the high cost of a variable annuity.

The pros and cons of owning an annuity

Guaranteed lifetime income is the biggest pro for including an annuity in a retirement plan. Outliving retirement is the risk retirees fear most and only an annuity can provide a guaranteed solution to reduce that risk.

Potential buyers might be concerned that access to the annuity value is restricted. Typically, the value is accessed only in the distribution phase, but what if the financial situation changes? Newer products allow for an annual withdrawal, such as 10 percent of the annuity value. Another concern about an annuity is the fear of dying before the value of the annuity has been distributed. Companies have addressed this objection by offering a death benefit to a named beneficiary.

Learn more

Ask us explain your product options. Heffernan Retirement Services believes that a comprehensive retirement plan should be diversified, and in some cases, an annuity may be part of that diversification. Our focus is learning about your retirement goals and concerns, then reviewing your plan to achieve those goals. Call us at 800.437.0045 to learn more about how an annuity may help achieve your retirement goals.