Annuity Quick Reference Guide
June 22, 2022 by Sheryl J. Moore
Many have never heard of annuities. Perhaps the easiest way to grasp the concept of annuities is to first discuss life insurance products. Life insurance is a contract that pays a benefit in the event you die unexpectedly. In turn, annuities are a contract that pay a benefit in the event you live too long.
Annuities are a vehicle that is used to save for one’s retirement, just as some use certificates of deposit (CDs), 401(k)s, bonds, mutual funds, and stocks. At a given point in every annuity, you can change it from a retirement savings vehicle, to a retirement income stream, through a process called annuitization.
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A top concern of Americans continues to be guaranteeing a minimum level of income during their retirement years. Coincidentally, annuities are the only financial instrument that can guarantee the purchaser an income for the rest of their life.
Annuities have long been known for their tax deferral qualities. Purchasers can use money that has not yet been taxed, to purchase the annuity. Thereafter, taxes are not paid until money is withdrawn from the contract. Plus, annuity purchasers earn interest on any interest earned, AND, those that purchase annuities earn interest on the tax savings that they would have paid as income taxes. This is often referred to as the “triple compounding” benefit, which is available through annuities.
Reliable and credible information about annuities is available through third-party market research firms that do not endorse any company or product, via an internet search of the word “annuity.”
Is an Annuity Right for You?
Annuities are not right for everyone, and no one should put 100% of their assets into an annuity. Below is a list of several things that may indicate that an annuity is right for you.
You are Looking for a Minimum Floor of Retirement Income
There is a minimum amount of income that we all need to pay our bills— the amount that isn’t expendable income. If you want to ensure that you have at least this level of income every month, an annuity might be right for you.
You are Concerned About Outliving Your Retirement Income
Americans are living longer than ever before, with the average life span reaching more than eighty years. That means a longer retirement than one may have counted on. Social security is only intended to provide less than 40% of your post-retirement income and the Social Security Administration’s 2014 report from the program trustees indicates that the trust fund reserves will fall to a point that Social Security will not be able to pay full retirement benefits starting in 2029. If you want to ensure that you have sufficient income to fund an extended retirement, an annuity might be right for you.
You Want to Reduce the Taxes on Your Paycheck
Annuities can be funded with pre-tax (qualified) dollars. You don’t pay taxes on the money that you put into these annuities, until you start withdrawing funds from your annuity purchase. It is important to note that while you may purchase an annuity while you are in a [38%] tax bracket, and plan to retire with a tax bracket of [20%], income tax rates are likely to increase over time. However, if you are interested in deferring the taxes that you pay on your income, an annuity might be right for you.
An Annuity Might Not Be Right for You
You are Looking to Maximize Your Return to the Fullest
Annuities offer an insurance element by guaranteeing a paycheck every month, for the rest of your life, even if you live to be 150 years old. Sometimes this means that the cumulative amount of income that you receive from the annuity exceeds the amount you paid into the annuity. This is a risk that the insurance company runs. Insurance costs money. If you don’t want to have to “pay” for the insurance in an annuity, these products may not be right for you.
You are Concerned About Having Immediate Access to All of Your Money
Annuities typically impose penalties in the event that you surrender or take excessive withdrawals from your annuity within a predetermined period of time. These surrender charges are imposed because when you purchase the annuity, you are telling the insurance company that they can use your funds to invest them, earn a return on them, and use the monies to help guarantee your paycheck “for life.” When you cash out your annuity early, the insurance company faces penalties on their investment of your annuity dollars. As a result, the insurance company passes on the surrender charges to most people that withdraw more than 10% of their annuity in any given year. If you are concerned about having immediate liquidity with your funds, an annuity may not be right for you.
You Feel That You Can “Build Your Own Annuity”
If you think that you can use your lump sum of money, and use it to emulate an annuity by purchasing some stock and a bond fund, you don’t understand an annuity in sum. Annuities provide a guaranteed paycheck for the rest of your life. No other financial instrument can provide this value proposition. As such, if you are looking to “build your own annuity,” an annuity may not be right for you.
Sheryl Moore is Shareholder and CEO of the life and annuity market research firm Wink, Inc. Wink provides competitive intelligence, market research, product development, consulting services, and insight to select financial services companies.
TRN00030 Rev. 5-2022
This article is for informational purposes only, you should not construe any information provided as legal, tax, investment, or financial advice. No reader should make any investment decision without first consulting her or his own financial advisor and conducting her or his own research and due diligence.
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