While you may have heard of annuities, many clients are confused by what these investments are, and rightly so.  Let’s start by defining what an annuity is.  Simply put, an annuity is a long-term contract issued by an insurance company, designed to help protect you from the risk of outliving your income.  The insurance company takes your investment and converts it into periodic payments that can last for the rest of your life. ¹ You can invest into an annuity with either a lump sum or a series of payments.

There are several types of annuities available, but we’ll simplify this by talking about the most common types.  The type of annuity you choose is generally based upon two factors:  the timing of when you would like to begin receiving payments and the growing of your annuity.  The start of payments may be immediately following a lump sum purchase (immediate annuity) or at some point in the future (deferred annuity).  When deciding how you want your annuity to grow, you can typically choose to grow through set interest rates (fixed annuity) or through investments in the market (variable annuity). ²

An example of an annuity that resonates with many people is a pension.  For employees that are entitled to pension benefits, either they or their employer (or both) has made contributions throughout the time worked at that company into a pension fund.  Upon retirement, that pool of money is converted into lifetime income for the retiring employee.  That guaranteed stream of income can continue through the retiree’s and, if elected, their spouse’s lifetime, regardless of what happens to the underlying investment in the pension fund.  Knowing this benefit will be there allows many retirees more confidence in their retirement.

Like most investments, there are pros and cons to purchasing annuities.  Here are some reasons to consider adding an annuity to your portfolio:

  1. Tax-deferred growth.  You won’t pay any income taxes on the growth of your annuity until you begin receiving payments.
  2. Lifetime Retirement income. An annuity can create consistent, steady income that won’t vary by swings in the market and can last for the balance of your lifetime.
  3. You can purchase additional guarantees, or riders, inside an annuity.  These riders vary and can include benefits like an annual growth lock-in, an enhanced death benefit, and guaranteed lifetime income payments.  (But these guarantees don’t come free.  Read on to see the cons of buying an annuity.)

Before purchasing an annuity, make sure you understand possible drawbacks.

  1. If you choose to annuitize a contract, once that election is made, you normally cannot change it. You may give up an asset or liquidity in order to guarantee a stream of income.
  2. If you decide to cash out an annuity, you may be subject to a surrender schedule which charges you a percentage fee based upon the number of years you have owned the account. These fees can be very costly.
  3. Those guarantees and riders mentioned in the pros list come at a cost to the investor. Fees vary depending upon the company and specific riders added to the contract, so be sure to understand all the fees involved to see if this is the right fit for your portfolio.  There is no need to pay fees for benefits that are of no importance to you.
  4. If you are under age 59 ½ and withdraw money from your annuity, you may be subject to a 10% early withdrawal penalty. This is applicable even on non-qualified money.  (Non-qualified money is after-tax money, or savings, that is invested, as opposed to pre-tax money that is invested in IRAs.) That tax-deferred growth you benefited from comes with restrictions, and this is an important one to consider.
  5. Any gains inside the annuity will be taxed at ordinary income tax rates, not capital gains rates upon withdrawal.

As with any investment, clients should carefully weigh whether an annuity is appropriate for them.  They should be viewed as a long-term investment designed for asset accumulation and retirement needs.  If you are interested in learning more about annuity options for your retirement portfolio, contact Hovis & Associates to schedule a meeting.

Disclaimer:  An annuity is a long-term-financial products designed largely for asset accumulation and retirement needs.  Annuities generally contain fees and charges which include, but are not limited to, surrender charges, administrative fees, and optional contract riders and benefits.  Withdrawals and death benefits are subject to income tax.  If withdrawals and other distributions are received prior to age 59 1/2, a 10% penalty may apply.  Annuities typically carry surrender charges for several years that may be assessed against withdrawals. Certain annuity product features, offered by some companies, such as a stepped-up death benefit, a bonus credit and a guaranteed minimum income benefit, carry added fees.  If you are investing in an annuity through a tax-advantaged plan such as an IRA, you will get no added tax advantage.  Under these circumstances you should only consider buying an annuity if it makes sense because of other features, such as lifetime income payments and death benefit protection.  All guarantees of an annuity are backed by the claims paying ability of the issuing insurer.

¹ https://www.nationwide.com/personal/investing/annuities/

² https://www.thrivent.com/insights/annuities/the-4-types-of-annuities-which-is-right-for-you#:~:text=There%20are%20four%20basic%20types,like%20your%20annuity%20to%20grow.