What is an Annuity?
An annuity is an insurance contract that provides a series of regular payments to an individual over a specified period of time. It is commonly used as a means of receiving a steady income during retirement or for long-term financial planning.
When you purchase an annuity, you typically make a lump-sum payment or a series of payments to an insurance company or financial institution. In return, the annuity issuer promises to provide regular payments to you, either immediately or at a future date.
The two types of annuities:
Immediate Annuities
With an immediate annuity, the individual starts receiving income payments shortly after making a large lump-sum deposit. The income payments can be received monthly, quarterly, annually, or on another schedule that the individual chooses. The amount of income payments is determined based on factors such as the individual’s age, gender, the lump-sum deposit, and prevailing interest rates.
Deferred Annuities
With a deferred annuity, there is an accumulation period that requires an individual to make a series of deposits before income payments begin. During the accumulation period, the funds in the annuity grow on a tax-deferred basis. Once the individual starts receiving income payments, usually at retirement, the annuity enters the distribution phase, on which they can receive monthly, quarterly or annual income payments.
Immediate Annuity (SPIA)
SPIA stands for Single Premium Immediate Annuity. It is a type of annuity that provides a guaranteed income stream immediately after making a lump-sum deposit. SPIAs are also known as an immediate annuity or income annuity.
When an individual purchases a SPIA, they make a one-time lump-sum deposit to an insurance company. In return, the individual immediately starts receiving regular income payments, typically monthly, quarterly, or annually. The income payments continue for the duration of the annuity contract, which can be for a specific number of years or for the rest of the individual’s life.
Key features of a SPIA:
Immediate Income
With a SPIA, the individual receives income payments shortly after making the initial premium payment. This can be beneficial for individuals looking to convert a lump-sum of cash, such as retirement savings, into a predictable and steady income stream.
Fixed Income Payments
The income payments from a SPIA are usually fixed and predetermined. The amount of each payment is determined based on factors such as your age, gender, the amount of money deposited, prevailing interest rates, and the terms of the annuity contract.
Guaranteed Lifetime Income Option
One of the common options for a SPIA is a lifetime income. With this option, the individual receives payments for the rest of their life, regardless of how long they live. This can provide a valuable source of income during retirement, eliminating the risk of outliving your savings.
Period Certain Income Option
Another common option for a SPIA is period certain income. With this option, the individual will receive income payments for a guaranteed period of time, usually for 20, 30, or 40 years. The advantage is that usually the period certain income payments are higher than lifetime income payments. If the individual doesn’t live the entirety of the guaranteed period, the income payments will be paid to a beneficiary of their choosing.
No Market Risk
SPIAs are not tied to market fluctuations or investment performance. The payments are guaranteed by the annuity issuer, offering stability and protection against market volatility.
Protection Against Inflation
SPIAs can provide inflation protection. This protection will vary between insurance providers and often time will need to be elected on initial application.
the two types of deferred annuities
An annuity is considered a deferred annuity by the simple fact that the individual purchasing the annuity isn’t receiving the income payments immediately following their initial deposit. The deferring of the income payment is also known as the accumulation period. The accumulation period can consist of three, five, seven, ten, or fifteen years and the individual can either do a one time lump-sum deposit or a series of deposits.
fixed annuity
indexed annuity
A fixed deferred annuity is a type of annuity contract that guarantees a fixed rate of interest over a specified period of time during the accumulation period. Often times fixed annuities are referred to as MYGA, which stands for Multi-Year Guarantee Annuity.
Key features of a fixed annuity (MYGA):
Guaranteed Interest Rate
The guaranteed rate of interest that the insurance company offers during the chosen one, three, or five year accumulation period. These interest rates are usually higher than conventional CDs and money markets offered by banks.
Tax-Deferred Growth
The growth of funds within a fixed annuity is tax-deferred. This means that the individual doesn’t have to pay taxes on the interest earned until they withdraw the funds.
Principal Protection
Fixed annuities offer principal protection, meaning that all deposit amounts are guaranteed by the insurance conmpany. Regardless of market fluctuations or investment performance, the principal is safe and will not decrease.
End of Contract Options
Upon the end of the chosen guaranteed accumulation period, the individual can choose to receive guaranteed income payments for life, start a new deferred annuity, or move their money elsewhere.
Fixed annuities (MYGAs) can be attractive to individuals seeking stability and predictable returns. They are particularly popular among those looking for a fixed-income investment with higher returns than traditional savings accounts or CDs or Money Markets.
An indexed deferred annuity, also known as an equity-indexed annuity (EIA) or a fixed-indexed annuity (FIA), is a type of annuity that offers the potential for higher returns based on the performance of a specified market index, such as the S&P 500 or the Dow Jones Industrial Average.
how indexed annuities work:
Interest Earnings
The annuity issuer credits interest to the annuity based on the performance of the chosen market index. The interest is calculated using a formula that considers the index’s growth over a specific period, such as a year. The formula may include caps, participation rates, or spreads, which determine how much of the index’s gain is credited to the individual’s annuity.
Minimum Interest Guarantee
Indexed annuities typically come with a minimum interest rate guarantee. Even if the chosen market index performs poorly or declines, the annuity will not earn a negative return. The minimum guaranteed interest rate ensures that the principal is protected.
Principal Protection
Indexed annuities offer principal protection, meaning that all deposit amounts are guaranteed by the insurance conmpany. Regardless of market fluctuations or investment performance, the principal is safe and will not decrease.
Tax-Deferred Growth
Like other annuities, indexed annuities offer tax-deferred growth, meaning the individual does not pay taxes on the earnings until they make withdrawals.
Indexed annuities can be attractive to individuals seeking to protect all retirement accounts from a previous employer. It allows them to have market participation without downside risk and avoid a conservative investment position.
Annuity as Alternative Concepts
Consider rolling-over past retirement accounts into a Indexed Annuity
Rollover a previous employer, 401(k), 403(b),TSP or IRA (Individual Retirement Account) into a qualified index annuity:
Principal Protection: Both qualified index annuities and previous employers’ traditional retirement accounts offer potential growth opportunities; only indexed annuities offer protection for the principal investment. Even in a market downturn, the roll-over transfer amount in an indexed annuity is protected.
Financial Stability and Income Needs: Consider financial stability and income needs. An indexed annuity can provide a guaranteed income stream in retirement, which may be beneficial if you desire a predictable and steady income.
No Required Minimum Distributions (RMDs): Once you reach a certain age (currently 73 years old), traditional retirement accounts typically require you to start taking required minimum distributions (RMDs) and pay taxes on them. In contrast, annuities do not have RMDs, giving you more control over when and how you access your funds.
Consider a Fixed Annuity instead of a CD or Money Market
Historically, it has been possible for a fixed or deferred annuity to offer a better interest rate than a certificate of deposit (CD) or a money market account.
Unlike CDs or Money Market accounts that are backed by the FDIC, a fixed annuity is backed by the financial strength of the insurance carrier.
One notable advantage of a fixed annuity is tax-deferred growth, which is not available with CDs or Money Market accounts. This means that taxes are not owed until the end of the contract.
When the fixed period of the annuity ends, typically aligned with the surrender period, there is flexibility to transition to another fixed annuity or explore alternative investment options.
Additionally, a fixed annuity grants limited access to your principal, often allowing up to 10% withdrawals or in the case of a qualifying life event. This feature sets it apart from CDs or money market accounts, where such access to principal is usually not available.
Consider Using a SPIA instead of withdrawal strategy from traditional retirement accounts
Guaranteed Income
SPIA: Provides a guaranteed, predictable stream of income for life or a specified period. Removes the risk of outliving savings, offering financial security and peace of mind.
Traditional Retirement Accounts: Income is dependent on investment performance and withdrawal rates. There is a risk of running out of money, especially if market returns are poor or if too much is withdrawn too quickly.
Simplicity
SPIA: Once purchased, requires no management or monitoring. Eliminates the need to make decisions about investments and withdrawals.
Traditional Retirement Accounts: Requires ongoing management of investments. Involves making periodic decisions about how much to withdraw, considering market conditions and personal needs.
Protection Against Market Volatility
SPIA: Insulates retirement savings from market fluctuations since the payout is fixed and not dependent on market performance.
Traditional Retirement Accounts: Subject to market risk; withdrawals during market downturns can significantly erode the portfolio’s value.
Longevity Risk Management
SPIA: Addresses the risk of outliving assets by providing a lifetime income and a potential to provide succession planning beyond the spouse.
Traditional Retirement Accounts: Requires careful planning to ensure the portfolio lasts through retirement, which can be challenging and unpredictable. Succession planning can become.complicated beyond the spouse.
Psychological Comfort
SPIA: Can reduce financial anxiety by providing a stable and predictable income. Helps retirees feel more secure about their financial future.
Traditional Retirement Accounts: Can be stressful due to market uncertainties and the responsibility of managing withdrawals and investments.
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