The future looks bright for the next generation of retirees – we're living longer, with the number of
So, what does that mean about the way we fund retirement? With more life to look forward to and more passions to pursue, it's essential that we try to build a
What are annuities?
Annuities can be a great addition to your retirement income plan, as they are one of the few investment solutions that can ensure you won't outlive your money. You may also enjoy the simplicity of regular payments. When selecting the type of annuity that's right for you, and based upon the terms of your contract, you can receive your payments without any additional effort.
There are two stages to any annuity contract.
- The first stage is the
accumulation stage , or the period where you save and potentially grow your retirement funds while building the cash value of your annuity.
- The accumulation phase ends at the onset of the distribution stage. This is when you're ready to begin withdrawing funds to create an income in retirement. With annuities, this is called
annuitization – or the process of converting your annuity into regular payments for retirement.
How you build your retirement funds and cash value (accumulation) and then convert those funds into guaranteed income (distributions) will depend on the type of annuity you purchase.
The 4 types of annuities
There are four basic types of annuities to meet your needs: immediate fixed, immediate variable, deferred fixed, and deferred variable annuities. These four types are based on two primary factors: when you want to start receiving payments and how you would like your annuity to be invested.
- When you are planning to begin receiving payments – You can either receive your annuity payments immediately after paying the insurer a lump sum (immediate payments) or you can receive monthly payments in the future (deferred payments).
- How your annuity investment may potentially grow – Contributions to an annuity can grow in a couple of different ways – through interest rates (fixed return) and by investing your contributions in the market (variable return).
1. Immediate annuities: The lifetime guaranteed option
One of the trickier elements in retirement income planning is figuring out how long you're going to live.
The drawback is that you're trading liquidity for guaranteed income. You generally won't have access to that full lump sum if you need it for emergencies. However, if securing lifetime income is a major concern, then a lifetime immediate annuity could be the right option for you.
A feature that can make immediate annuities so appealing is that the fees are woven into the payout. This allows you to know exactly how much money you'll receiving in the future, for the rest of your life and your spouse's life based on the amount you originally contributed.
Financial organizations like Thrivent that offer immediate annuities frequently offer additional income payout options, like recurring payments over a fixed term, or until you die. You may also have an optional death benefit which allows you to have payments sent to people and/or causes of your choosing.
2. Deferred annuities: The tax-deferred option
Deferred annuities are a great option if you want to contribute your retirement income on a tax-deferred basis – meaning you are not taxed on the retirement income until you take money out. Unlike IRAs and 401(k)s, there are no contribution limits for deferred annuities.
3. Fixed annuities: The lower-risk option
When your contract is over, or at the end of the guarantee period, you may choose to either annuitize your contract, renew your contract, or transfer your invested dollars into another annuity contract or retirement account.
Because fixed annuities offer a guaranteed interest rate, your income is typically not impacted by market volatility so you can anticipate the amount of your monthly payments. Of course, a downside of remaining in a fixed annuity with a guaranteed interest rate would be the inability to benefit from potential upswings in the market. In addition, the guaranteed interest rate may not keep pace with inflation. All in all, a fixed annuity may offer the most benefits during an annuity’s accumulation phase and be less effective during the annuitization phase for generating retirement income.
4. Variable annuities: The potentially highest upside option
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Like mutual funds, sub-accounts are dependent upon market risk and performance. Variable annuities also offer a death benefit rider or an income rider that provides your beneficiaries a guaranteed income. A guaranteed lifetime withdrawal benefit, or GLWB, is a rider which helps protects against both longevity risk and market risk. This dual protection may be beneficial if you are 15 years or less from retirement.
A variable annuity can be a great addition to your retirement income plan if you've already maxed out your Roth IRA or 401(k) contributions for the year. You may also wish to consider adding guaranteed income riders to your variable annuity. Guaranteed income features may allow you to feel more confident about the future so you can focus on your goals in the present knowing you won't outlive your money.
The pros & cons of the types of annuities
Fixed AnnuitiesProvide a fixed interest rate on your investment for a set period | Variable AnnuitiesProvide growth potential of the market through sub-accounts | |
Immediate AnnuitiesPay a lump sum and receive guaranteed income right away | Type 1: Immediate FixedPros: Receive income right away, simplicity of not needing to monitor investment, know exactly how much money you'll receive in payout Cons: Payments can end upon the death of the annuitant; may not keep pace with inflation; trading liquidity for guaranteed income | Type 2: Immediate VariablePros: Guaranteed lifetime income right away, opportunity to benefit from the market, death benefit for beneficiaries Cons: Less common and can be more expensive than other retirement options; monthly payments may fluctuate based on the market |
Deferred AnnuitiesPay a lump sum or income premiums to receive guaranteed income at a set future date | Type 3: Deferred FixedPros: Easier to understand; principal protection; payment timing flexibility; tax-deferred growth during accumulation phase; No annual contribution limits; Not impacted by market volatility Cons: Subject to early-withdrawal penalties; may not keep pace with inflation | Type 4: Deferred VariablePros: Tax-deferred growth during accumulation phase; potential to benefit from the upside of the market Cons: Subject to early-withdrawal penalties; assets subject to market fluctuation |
Are annuities right for you?
Annuities can offer a sense of confidence when it comes to income in retirement. That being said, the purchase of an annuity should be carefully discussed with a financial advisor. They will consider your goals, values and financial situation prior to making a recommendation about an annuity or other investment product.
Curious about your income needs in retirement? Take the
Learn more about how annuities can help you reach your retirement goals,