Before you decide to invest in annuities, you need to know a few things about them so you can make sure it is the right kind of investment for you. While considering an annuity might seem like a wise choice on the surface, they are often misused and misunderstood. You may hear from the insurance agent that by buying an annuity you could end up with an income stream that outlasts you. The annuity payments are expected to last just so long as you live – or they may last longer because the payments are based on your life expectancy.
- First, you need to know what an annuity is and understand how it works. Basically, an annuity is a contract between you and your insurance company to cover the goals that you need or want to cover, such as taking care of your long-term care needs, providing lifetime income, or principal protection. While an annuity is considered an investment, it is not because it locks you and your insurance company into a contractual obligation. If you can break the contract, it may be costly.
- An annuity works by transferring the risk from the owner to the insurance company. Like many other kinds of insurance, you pay premiums to the insurance company so they will bear the risks. These premiums could be in the form of a single lump sum or in a series of payments, which depends on the specific kind of annuity you purchase. Annuities can be structured so that payments are distributed to you and your heirs for a set number of years, for your lifetime, until both you and your spouse have died, or they could have a guaranteed payout and pay for life with a certain time frame.
- There is one kind of annuity that is called an immediate annuity. While it is annuitized immediately, it doesn’t start paying income to you immediately. You make a lump sum payment to the insurer and then you start receiving income one annuity period after you complete your purchase, which depending on the insurance company, could range from 30 days to a year later.
- When you go for a deferred annuity, you can get tax savings while setting up lifetime income. With this kind of an annuity, you will start getting payments years down the road. Until that time, your premiums will continue growing tax-deferred in the annuity. These annuities are helpful in supplementing other retirement accounts because they have no contribution limits per IRS guidelines. Your only limit is the amount of premiums that the insurance company is willing to accept for your annuity purchase.
- If you withdraw money from your annuity before its time to do so, you could face surrender charges or withdrawal penalties. Surrender periods can range anywhere from 2 years to 10 years, and usually, the corresponding charges reduce over time. Be sure to check the term before you purchase an annuity. As an example, if you buy a deferred annuity that has a 10-year surrender time frame and you withdraw funds the first year, you would pay a 10 percent penalty. If you withdraw funds the third year, your penalty would be 8 percent.
To learn more about annuities and determine if you should add one to your portfolio, talk with the experienced financial experts and tax advisors at MKS&H today.