What Is An Annuity?

Immediate vs. Deferred Annuities

With immediate annuities, you start with a large sum of money and begin receiving regular payments one period after your initial purchase.

• Immediate annuities are typically favored by individuals between the ages of 55 and 80.
• You accumulate money on a tax-deferred basis only during the early payout years.
• Only the portion of income derived from contract earnings is taxed.
• Payments end after you pass away. Payments may continue to beneficiaries after your death if the annuity has a guaranteed period that hasn’t expired.

Deferred annuities accumulate value over a period of several years, with payments beginning at a later time determined by the individual.

• Deferred annuities are often purchased between the ages of 40 and 65.
• Earnings are accumulated on a tax-deferred basis.
• Only the portion of benefits derived from interest income is taxed.
• Your beneficiaries receive a death benefit.

Other Options

Annuities come with additional options that you may want to discuss with your financial professional.

• Indexed annuities. Sometimes called equity indexed annuities, this is a more complex product that combines features of fixed and variable annuities. You receive a guaranteed minimum interest rate along with a second interest rate that is tied to a market index, such as the S&P 500 Composite Stock Price Index. 
• Qualified vs. non-qualified annuities. With a qualified annuity, you put money into a tax-favored plan such as an IRA or 401(k). A non-qualified annuity is purchased separately from a tax-favored retirement plan.
• Single-premium vs. flexible premium annuities. As the name implies, a single-premium annuity is funded by a single payment. Flexible premium annuities are funded by a series of payments over time.
• Guaranteed benefits. If you choose an annuity with a guaranteed death benefit, your beneficiary will receive payments if you pass away before the withdrawal date. With a guaranteed minimum income benefit, you receive a minimum ongoing payment regardless of market fluctuations.

What Are the Advantages of Annuities?

As with all financial products, annuities may be a more optimal choice for some individuals than for others.

Here are a few of the potential advantages that annuities may offer:

• Guaranteed income stream. Especially if you choose a fixed annuity, you receive predictable payments that are somewhat protected from market fluctuations.
• Tax deferment. While your earnings are taxed at the current income tax rate upon withdrawal, your principal is not taxed.
• Income outlives you. Annuities can be structured to provide a steady stream of income for a set period of time or for the remainder of your life.
• No contribution limits. Unlike other retirement accounts such as 401(k)s and IRAs, you may put in as much money as you wish.

What Are the Disadvantages of Annuities?

Before purchasing an annuity, here are a few possible drawbacks you’ll want to be aware of:

• Fees. Annuities often carry fees or other charges, so be sure and read the fine print before committing. Agent fees or commissions are paid by the insurance company, unlike brokerage accounts where the client pays a fee directly to the agent . However, there can be extra fees for optional riders. These options might cover benefits such as higher income percentage, or access if you become disabled or move to a care facility.
• Early withdrawal penalties. Withdrawal before age 59 ½ may incur a 10% income tax penalty, on top of income taxes on earnings.
• Giving up access to savings. If you need access to your money before withdrawals are allowed, annuities may not be the best option for you.
• Complexity. As we’ve pointed out in this article, there are many different types of annuities. While this gives you the flexibility to choose the option that’s best for you, it may also make your decision more complicated. That’s why it’s important to talk with a trusted financial professional to go over all of your alternatives before making a final decision.
• Term variability. Annuities vary in terms, or the number of years that your balance would be insured for. If you need to withdraw more than the allowed amount you may pay a penalty.