The way annuities work may at first seem a bit complicated. That’s because these financial products can have many moving parts. But, by having a good understanding of the benefits, you could enhance the income you receive in retirement, as well as your tax-advantaged savings options during your working years.
Annuities are an insurance product, and because of that, they offer some enticing guarantees – which include the ability to continue paying you an income stream for your entire life, regardless of how long that may be.
Because of this, owning an annuity can alleviate one of the biggest fears on the minds of retirees – running out of money in the future. So, stop asking yourself “how do annuities work?”, and allow the experts at Annuity Gator to help you to narrow down which annuity (if any) is right for you and your financial objectives.
Although annuities have become more popular over the past decade or so, these financial vehicles have actually been around for thousands of years. In fact, they are one of the oldest forms of investments, dating all the way back to the Roman Empire.
The most common question we get is “how do annuities work? ” We’re here to help answer that. In their most basic sense, annuities are defined as a contract between an individual and an insurance company. This contract can guarantee the annuitant (i.e. the person on whose life the annuity is based) an income that cannot be outlived.
This makes annuities a good option for those who are seeking a reliable source of incoming cash flow. In addition to an income stream, though, annuities can also offer a long list of additional benefits.
Although annuities have become more popular over the past decade or so, these financial vehicles have actually been around for thousands of years. In fact, they are one of the oldest forms of investments, dating all the way back to the Roman Empire.
The most common question we get is “how do annuities work? ” We’re here to help answer that. In their most basic sense, annuities are defined as a contract between an individual and an insurance company. This contract can guarantee the annuitant (i.e. the person on whose life the annuity is based) an income that cannot be outlived.
This makes annuities a good option for those who are seeking a reliable source of incoming cash flow. In addition to an income stream, though, annuities can also offer a long list of additional benefits.
One of the most distinguishing features of an annuity is whether it is fixed or variable. While both types of annuities may be funded in a similar manner – and also offer like payout options – there is a definite difference between how the different types of annuities operate. Let’s dive in to discover how annuities work.
In addition to the way in which the return is calculated, annuities can be further separated into immediate and deferred categories.
Many annuities offer additional features, too. In some cases, these add-ons are included at no additional charge, while others will require you to pay an additional amount of premium. One feature that many annuities include is a death benefit whereby if the annuitant passes away prior to receiving all of their contributions back, the remainder of the funds are paid to a named beneficiary.
This annuity death benefit can be taken either as a single lump sum, or alternatively as a stream of payments. Unlike the death benefit from a life insurance policy, though, annuity death benefits are usually taxable.
There may also be a terminal illness and/or nursing home waiver on many annuities. With these features, if the annuitant is diagnosed with a terminal illness or has to reside in a nursing home for a certain period of time, funds may be accessed from the annuity penalty-free.
While annuity guaranteed income is certainly a key benefit with these financial vehicles, there are other ways that annuities can help you reach your financial goals. In order to ensure you have the right annuity in place, though, it is important that you know what you want the annuity to do.
For instance, while many retirees love knowing that they will have a reliable income to count on in the future, other investors may prefer the tax-deferral that annuities provide during the accumulation period. This is particularly the case if the annual contribution on their qualified savings plans like an IRA and employer-sponsored plan has been “maxed out”.
While annuity guaranteed income is certainly a key benefit with these financial vehicles, there are other ways that annuities can help you reach your financial goals. In order to ensure you have the right annuity in place, though, it is important that you know what you want the annuity to do.
For instance, while many retirees love knowing that they will have a reliable income to count on in the future, other investors may prefer the tax-deferral that annuities provide during the accumulation period. This is particularly the case if the annual contribution on their qualified savings plans like an IRA and employer-sponsored plan has been “maxed out”.
Both 401(k) plans and annuities are considered financial vehicles that can help you to save for retirement. Therefore, these options have some similarities and some differences. The good news is that there is actually a way to benefit from both.
In terms of their similarities, annuities and 401(k) plans allow your savings to grow on a tax-deferred basis. This means that your funds can compound year after year without be subject to tax until the time of withdrawal.
When it comes to providing an income stream, though, annuities and 401(k) plans can differ quite a bit. For instance, a 401(k) can only pay out the amount of money you put into it, plus its earnings. This means that eventually, these funds may run out.
On the other hand, with the lifetime income option on an annuity, you can rely on an income stream for the remainder of your life – even if you live for many years. This is true, regardless of what happens in the stock market, or even in the economy overall. For this reason alone, it proves how important it is to understand how annuities work, especially when compared to 401(k) plans.
Just like any other type of financial vehicle, annuities can have both pros and cons. For instance, there are a number of annuity advantages, such as:
Yet, even with all of the benefits that annuities offer, there can also be some drawbacks to be mindful of. First, annuities are not very liquid. For instance, in most cases, you may only withdraw up to 10% of your contract value each year.
However, if you take out more than that during the annuity’s surrender period, you can incur a withdrawal charge. On some annuities, the surrender period can last up to 10 years, or even longer.
In addition, if you withdraw money from an annuity before you are age 59 ½, you may also be hit with a 10% “early withdrawal” penalty from the IRS. So, annuities should always be considered a long-term financial commitment.
With that in mind, another item to consider is annuity fees. Most annuities will have surrender fees. Depending on the annuity, there may also be an agent commission deducted from your contribution when you purchase it.
Variable annuities will typically have some additional fees, as well. Depending on the particular variable annuity, these fees can include:
Keep in mind that variable annuity fees are not just based on the annuity itself, but they can also be garnered from each of the individual investment options you have chosen. Altogether, variable annuity fees can often cut into 2% or more of your annual return.
Although annuities can provide a number of enticing benefits – such as tax-deferred growth and a guaranteed income stream – these financial vehicles may not be the right fit for everybody.
Further, even if you can benefit from an annuity, there are many different types of these products available in the marketplace. So, it can help to work with an annuity specialist who can assist you with narrowing down the right one for you and your specific objectives.
Annuity Gator provides in-depth education about annuities to consumers and financial professionals, making these complex financial vehicles much easier to understand. We also offer in-depth details and reviews on hundreds of annuities in our annuity review database. Learning about how annuities work is essential for determining whether or not a particular annuity may be right for you.
If you’ve got questions about annuities, Annuity Gator can help you find the answers. We’d be happy to chat with you. So, feel free to call us directly at (888) 440-2468, or send us an email through our secure online contact form and set up a convenient time to talk.
Although annuities can provide a number of enticing benefits – such as tax-deferred growth and a guaranteed income stream – these financial vehicles may not be the right fit for everybody.
Further, even if you can benefit from an annuity, there are many different types of these products available in the marketplace. So, it can help to work with an annuity specialist who can assist you with narrowing down the right one for you and your specific objectives.
Annuity Gator provides in-depth education about annuities to consumers and financial professionals, making these complex financial vehicles much easier to understand. We also offer in-depth details and reviews on hundreds of annuities in our annuity review database. Learning about how annuities work is essential for determining whether or not a particular annuity may be right for you.
If you’ve got questions about annuities, Annuity Gator can help you find the answers. We’d be happy to chat with you. So, feel free to call us directly at (888) 440-2468, or send us an email through our secure online contact form and set up a convenient time to talk.
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