When it comes to investing, there are countless principles and strategies to sort through in order to create an investment portfolio that best suits your personal risk tolerance, timeline, and overall goals.
In this post, we will discuss what annuities are and how they work, as well as the advantages and drawbacks that may be important for individual investors to consider before committing to a long-term contract. Here are ten things you need to know about annuities:
- What are annuities?
An annuity is a contract with an insurance company that guarantees current or future payments in exchange for a premium or series of premiums. It is designed to provide a steady stream of income throughout your retirement years. The interest earned on an annuity contract is not taxable until the funds are paid out or withdrawn. Withdrawals and income payments are taxed as ordinary income.
- Annuities are simple – and complex.
The guarantees of an annuity contract depend on the issuing company’s claims-paying ability. Annuities have fees and charges associated with the contract, and a surrender charge may also apply if the contract owner elects to give up the annuity before certain time period conditions are satisfied.
Annuities can be overly complicated, but when you pare it down, they are an insurance product that comes in various shapes and sizes. The purchaser is essentially paying an insurance company to take on the risk of them outliving their personal retirement savings.
- What is the advantage of purchasing an annuity?
The primary benefits of owning an annuity are amassing cash on a tax-deferred basis and earning an income in retirement even after the annuity contract has run out of money. For individuals who have already maxed out other tax-favored retirement plans, annuities may be worth considering.
- Annuities come in many forms.
Fixed annuities are a contract with an insurance company that guarantees investment growth at a fixed interest rate as well as current or future payments in exchange for a premium or series of premiums. The interest earned on an annuity contract is not taxable until the funds are paid out or withdrawn. The guarantees of an annuity contract depend on the issuing company’s claims-paying ability. Annuities often have fees and charges associated with the contract. A surrender charge may apply if the contract owner gives up the annuity before meeting certain time period conditions.
Variable annuities allow the individual to receive larger future payments if investments in the annuity fund do well. If the investments fare poorly, the individual receives smaller payments.
- You decide how to pay for the annuity.
Annuities are available in single and multiple premiums. People with a large sum of money, perhaps acquired through an inheritance or from years of doubling down and saving, may opt to make one large payment for an annuity. Others may prefer to pay for an annuity in a series of payments spread over several years.
- Annuity payments to you can be immediate or deferred.
Immediate payout annuities start paying as soon as the individual deposits a lump sum. Alternatively, deferred fixed annuities do not start to pay out after the initial investment, but rather at the age the client specifies they would like to begin to receive payments. These can last for a set period.
Taxes on earnings above the initial investment are deferred until withdrawals begin. The purchaser can also decide whether the annuity payments will last for a lifetime or a fixed period ranging from 5 to 25 years.
- Cashing out early on annuities will result in fees.
If a situation arises and an individual needs to take out money from a deferred annuity before age 59.5, a 10% early withdrawal fee will apply – in addition to potential income taxes.
Typically, the annuitant is also required to pay a surrender charge that ranges from 7% to 10% of the account balance in the first year. Luckily, this charge progressively decreases each year until it fully disappears after 7 to 10 years.
- Inflation-adjusted annuities are available.
Standard immediate annuities are appealing because of their guarantee for the purchaser to receive an annual fixed payout for the duration of their life. However, inflation could easily gnaw away the value of those payments over time.
It can be helpful to inquire about cost-of-living adjustments for annuities. Opting for such adjustments will decrease the initial payout but will ultimately increase payments on a long-term basis to (hopefully) keep up with inflation as time passes.
- Annuity growth will not be taxed, but withdrawals and income payments will be.
Interest accumulates tax-deferred on an annuity and is not taxed until it is withdrawn. With deferred annuities, the individual chooses when to withdraw interest. The interest credits and gains on all types of annuities are taxed as ordinary income – not as long-term capital gain income.
- Understand surrender charges before you make your annuity selections.
Surrender charges are a standard part of all deferred annuities. This is the penalty the insurance company will charge an annuity contract owner if they cancel their deferred annuity contract before the agreed-upon surrender charge period.
Surrender charges are also generally doled out when someone withdraws a portion of their account balance above their designated penalty-free withdrawal amount. Surrender charges are usually higher in the contract’s early years and decrease over time until the contract has been completed.
If the annuitant moves into a qualified facility for long-term care or becomes terminally ill, the surrender charges are often waived.
Connect With Top Financial Advisors in Denver, CO
If you are considering adding annuities to your retirement planning strategy mix, we are here to help. Talk with our team of top registered investment advisors in Denver, CO at Triumph Capital Management by calling us today at (720) 399-5555. Or visit us online to book a complimentary consultation.
Triumph Capital Management
1610 Wynkoop Street Suite 550
Denver, CO 80202
Advisory services offered through Triumph Capital Management, a registered investment advisor SEC#282814. Insurance Services offered through Triumph Capital, LLC #619821