Annuities are some of the most popular ways to secure both short- and long-term funds for developing retirement strategies, managing taxes, diversifying your investments, and more. But until you’re in need of an annuity, it can be difficult to understand what an annuity actually is and what situations you would need to utilize one for.
Understanding the difference between good and bad annuity rates is just one piece of the puzzle. For example, there are many different types of annuities that can offer a variety of services, including:
- Fixed annuities
- Variable annuities
- Fixed-index annuities
- Immediate annuities
- Deferred annuities
- Single-premium immediate annuities (SPIAs)
- Qualified longevity annuity contracts (QLACs)
Each type of annuity listed above demands a different procedure and has a different set of rules. In this blog, we’ll break down the differences between these annuities, educate you on what an annuity contract entails and what an annuity is generally used for, and debunk five common myths about annuities in general.
What Is An Annuity?
An annuity is a contract with an insurance company that investors might consider when planning for retirement or seeking to turn assets into a stream of income. The most common use for an annuity is for retirement planning and keeping money coming in for when a person is done working.
Annuities are generally funded with a lump sum payment or divided up into monthly payments. In exchange, the insurance company will make payments to you over time after you’ve funded your annuity to ensure a steady stream of income.
Annuities are tax deferred. This means annuities allow taxpayers to reduce their taxable income by contributing pre-tax funds to an annuity premium. So while they don’t allow you to avoid taxes completely, they can allow you to limit your taxes taken out of your overall income, thus saving you money.
Breaking Down The Different Types of Annuities
There are many different types of annuities to consider depending on a person’s plan and financial situation. Below is a breakdown of the different types of annuities.
- Fixed Annuities: A fixed annuity is ideal for guaranteed income. This means a fixed annuity guarantees a certain interest rate for a determined period of time. Fixed annuities are not reliant on market performance and have low risk.
- Variable Annuities: As its name suggests, a variable annuity provides periodic payments depending on the performance of your investments in the market. Your payments aren’t guaranteed, and this makes the risk level high. But the reward can be high as well.
- Fixed-Index Annuities: These annuities still rely on market performance, but the risk is lower because fixed-index annuities can limit how much you can gain or lose by cutting you off one way or the other. These generally guarantee a minimum rate of return.
- Immediate Annuities: These annuities are funded with a single lump sum payment and allow you to receive annuity payments immediately through guaranteed monthly payouts.
- Deferred annuities: The opposite of immediate annuities, deferred annuities allow you to determine a point in the future when you’ll start receiving annuity payments. Your money can accumulate for longer if you can wait to receive the payments at a later date. These are generally purchased for future retirement income.
- SPIAs: A single premium immediate annuity is “an annuity purchased with one large upfront payment. The SPIA immediately begins paying you back your purchase price plus a modest interest rate in installments” (Forbes).
- QLACs: A qualified longevity annuity contract is “a type of annuity contract specifically designed to keep you from outliving your retirement savings” (Forbes).
If you have the ability to wait until a later date to receive your annuity payments, a variable annuity can be a solid investment with the potential to reward you handsomely. Just remember the risk that comes along with it.
But if you need guaranteed annuity payments rather quickly, choose a fixed annuity rate and start getting paid. Each person’s situation is different and should be handled with the help of an annuity professional since annuities can be complex. Consult with your local digital accountant about whether an annuity is the right financial investment.
With the slew of information that comes with the different types of annuities, it can get confusing easily. Below we debunk some of the most common myths about annuities.
4 Myths About Annuities
- Annuities are always safe investments
This is sadly not true. Because annuity advisors can earn commission payments based on selling annuities, theoretically you could get ripped off from an annuity firm. In some unfortunate cases, the goal in certain offices is to get you to sign the line so they can get paid, versus your best interest being at the top of their priority list at all times. Make sure you trust your annuity advisor as much as your accountant or bank representative.
- Annuities come with hidden fees
While certain variable annuities can come with risks that could result in you losing your money or investment through fees, fixed annuities will lock you in with no maintenance fees, or annual payments. A trusted annuity advisor will ensure transparency throughout the annuity process and provide you with all the information you will need about your plan with no surprises to come later.
- Annuities are only for those planning for retirement
Annuities can be solid options for those simply looking to save or grow their money. You don’t need to be preparing for a long-term stream of income solely from annuities, like in retirement, to invest in them. Deferred annuities allow you to grow an investment that is more-or-less tax free potentially. You can allow this to grow while setting a future date to receive payments, which could be well before you plan to retire.
- Annuities are always expensive investments
Not always. Some annuities can come at a very low cost. If you’re in the annuity game just to save money, choose a low-cost deferred annuity that allows you to grow money over time. Though annuities are notorious for being expensive in certain cases, this isn’t always the case. Often you can tailor an annuity to your specific situation and needs.
Final Word
Entering the world of annuities can be a confusing and overwhelming process. There can be a lot of moving parts and different types of annuities that come with different rules and unique factors. Whether you’re looking for an immediate annuity or want to defer your payments down the line, an annuity professional can help you decide which annuity is right for you
