An annuity is an investment option that can provide a guaranteed income for an individual or their spouse throughout their retirement. They are purchased for a set period and pay out a specific amount in retirement based on the investment strategy and amount invested.
Annuities may be good for people who want a lifetime income during their retirement and may have concerns about outliving their savings. Other factors should be taken into consideration before getting an annuity. Annuities are designed to be a long-term component of a financial plan along with other retirement income streams.
What Are the Different Types of Annuities?
There are several different types of annuities. The two major categories are broken down by how quickly they pay out: immediately versus on a deferred basis. These two major categories are then further divided into five main ones, which will be discussed in detail below.
Deciding which one to choose will depend on several factors, such as how quickly someone wants to be paid, how willing they are to take risks, their income goals, and so forth. Each type comes with its own advantages and disadvantages.
The following is a list of the five main types of annuities:
- Fixed annuities: Fixed annuities provide regular periodic payments to the annuitant. They are typically issued by insurance companies, as opposed to financial firms. They are structured to provide a standard interest rate, are relatively low cost, and are useful for persons seeking a predictable source of income for when they retire.
- Variable annuities: Unlike fixed annuities, variable annuities will not pay out yearly. Instead, the money will be invested into various mutual funds and securities, which the insurance company will manage. Variable annuities allow the owner to receive larger future payments if investments do well and smaller payments if its investments do poorly. This provides for less stable cash flow than a fixed annuity but allows the annuitant to reap the benefits of strong returns from their fund’s investments. Riders and features can be added to annuity contracts for an extra cost. This allows them to function as hybrid fixed-variable annuities. Contract owners can benefit from upside portfolio potential while enjoying the protection of a guaranteed lifetime minimum withdrawal benefit if the portfolio drops in value.
- Fixed-Indexed annuities: These are a combination of the two just discussed. They provide a minimum standard income, but they also generate a fluctuating rate of interest based on stock market indices, such as the S&P 500. However, there is usually a cap on how much the person can receive if the market index performs well.
- Immediate annuities: Immediate annuities offer the highest payouts. They operate similarly to life insurance policies. The annuitant will invest a large lump sum payment, which will then start to be distributed about a year later. These work best for persons willing to sacrifice funds upfront and looking for a high-income stream later in life.
- Deferred annuities: Other annuities begin to pay out after one year, but deferred annuities delay disbursements until more than a year has passed. They happen to be cheaper overall since the insurance company will not have to return any payments immediately. The downside here is that the person will have to wait until they start generating an income stream.
Who Can Sell Annuities?
Annuities can be purchased from an insurance company or a financial investment firm. Annuities are typically regulated by two federal agencies: the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). Regardless of whether the seller is an agent of an insurance company or a financial firm, they must possess a license to sell annuities.
Some examples of places to purchase annuities from include:
- Financial advisors
- Brokerage firms
- Independent brokers or agents
- Large banks
- Mutual fund sellers
An individual seeking to purchase annuities must conduct substantial research on the companies with whom they plan to do business. Trustworthy authorities (e.g., attorneys and accountants), word-of-mouth referrals, and online reviews are wise ways to get good referrals and to investigate a company before purchasing annuities.
Who Can Buy Annuities?
Realistically, anyone who wishes to purchase an annuity can buy one. However, they are particularly useful and prudent for certain people:
- One type of individual who may want to consider purchasing an annuity is a defendant in a personal injury case. The payouts can be used to pay off a judgment or to make settlement arrangements with the plaintiff.
- Another person who may want to invest in one is someone looking to retire or who needs long-term care due to illness. The annuity provides a stream of income that they can rely on instead of a work salary.
- On the other hand, someone who is young and healthy may be better off investing directly in the stock market since (a) they can still work and may not need a second income stream, and (b) being young, may not be able to make large up-front lump sum payments yet.
What are the Different Types of Payout Options?
As previously discussed, the two major categories of annuities are based on how they are paid out: immediate versus deferred payments. A person who opts for an immediate plan must pay a large, one-time lump sum amount upfront. This means they will lose a large amount of money at first but in return, will have a steady, immediate, and long-lasting income to retire on.
On the other hand, if a person chooses one of the deferred payment options, then they need to select a date for when their payments should start. This date will then become part of the contract terms. As they make regular payments into the annuity, the annuity will earn interest and grow larger over time. As long as the annuity continues to earn interest and is not paying out, it will remain untaxed. However, if the annuitant chooses to take the money out before it is due, there will be tax penalties.
Once the money begins to be disbursed from a deferred payment annuity, the interest will be taxed normally.
What Happens to My Annuity When I Die?
If the individual with the annuity becomes deceased before it pays out, then one of two things may happen:
- First, the beneficiary may assume or take over their payments, meaning they will be responsible for the contract terms until the full annuity is reached and can be paid out.
- Second, If they do not wish to take over payments, they can receive the current cash value of the annuity.
However, sometimes the beneficiary will not have an option because the annuity contract states which option will occur upon the death of the annuity holder. Therefore, it is very important to read the terms of an annuity contract before signing so that your beneficiary will have whatever options you want them to have.
When Do I Need to Hire an Attorney for Annuity Issues?
If you are considering entering into an annuity arrangement. Annuity contracts are very complex, and the language can be hard to interpret. An annuity attorney can help you ensure that you know the annuity contract terms and that they are satisfactory to you.
Additionally, an attorney experienced with annuities can help you decide which type of annuity will best accomplish your goals.
Furthermore, if a dispute arises between you and the insurance company or investment firm, such as you are not receiving payments you are entitled to receive, you may want to consider hiring a business or annuity lawyer, especially if you have to appear in court.
