Annuities are insurance-backed contracts that can provide you with guaranteed income during retirement. The most common annuity types are deferred, immediate, variable, and fixed. It’s essential to compare the pros and cons of each annuity type to understand each and choose the one that best aligns with your financial goals.
What is an Annuity?
An annuity is a retirement tool that provides you with income during retirement. Annuities are agreements with the insurance company that can be used to collect guaranteed monthly payments to supplement your income once you retire. Different annuity types determine how much you receive and when after contributing to one.
What is an Immediate Annuity?
An immediate annuity is an investment tool that offers immediate payments. Immediate annuity payments begin shortly after you make a lump sum contribution and typically extend for life. An immediate annuity can be fixed or variable. Immediate annuities are sometimes called income annuities because you can turn them into monthly income payments.
While there are many ways to fund an immediate annuity, a 401(k) transfer is the most common. One of the downsides of an immediate annuity is that you have to give up a large lump sum of cash in return for guaranteed payments. You’ll want to ensure you have access to other emergency savings in case you need cash during retirement.
What is a Deferred Annuity?
A deferred annuity refers to any annuity that begins issuing payments at a later date. Deferred annuities have more time to grow, which can benefit both a fixed or variable annuity. Perhaps one of the biggest advantages of a deferred annuity is its tax-deferred growth. With a deferred annuity, your earnings will continue accumulating, and you won’t owe taxes until you begin collecting payments. Because many people wait until they retire to collect annuity payments, they often pay fewer taxes because they’re now in a lower tax bracket.
Another advantage of deferred annuities is that there aren’t any contribution limitations. The more you contribute, the higher your monthly payments may be during retirement. A deferred annuity allows you to choose your payment schedule, including how long you want to receive monthly payments. Similar to an immediate annuity, deferred annuities can be fixed or variable rate. You can fund a deferred annuity either through a lump sum payment or through monthly premiums.
One of the downsides of a deferred annuity is that they often charge expensive surrender or early withdrawal fees if you need access to your money before the contract matures. You may also be subject to tax penalties if you withdraw the funds before you retire.
What is a Fixed Annuity?
A fixed annuity offers a guaranteed rate of return, regardless of how well the market performs. The insurance company that backs the annuity promises a set rate of return that you’ll receive at a future date. The insurance company then invests your annuity contribution into low-risk investments, like securities and bonds. However, you’ll receive your promised rate of return regardless of how well that investment performs.
A fixed annuity’s downside is that the guaranteed rate is often less than other riskier investments. The guaranteed and predictable income and reduced risk may appeal to those nearing retirement or investors who already have high-risk investments. With a fixed annuity, you don’t have to worry about a volatile market that could otherwise affect your retirement plans.
Another downside to a fixed annuity is that it may not always keep up with inflation. The guaranteed interest rate you earn from a fixed annuity may not outpace the increasing value of goods, making it less valuable.
What is a Variable Annuity?
A variable annuity issue returns based on market performance. You still purchase a variable annuity from the insurance company, which then invests those funds and others into chosen mutual funds. Your returns, as a result, will vary depending on the performance of those collections of funds.
If the chosen funds do well, you could earn more returns than other annuity types. However, if the market doesn’t perform well, it’s possible to lose money. While a variable annuity could outpace inflation, this isn’t guaranteed. You could earn less with a variable annuity than a fixed one, depending on market performance.
The best annuity type depends on many factors, including age, retirement plans, risk tolerance, and current investment portfolio. Compare each annuity’s payout schedules and contribution requirements to find the right one for you. Make sure you consider your retirement plans and financial needs when choosing the best financial tools.
Ismail is a freelance tech writer with a passion for lifestyle, gadgets, apps, and cars. My writings carry a huge amount of different social aspects that may help to improve your lifestyle. Find him by email.
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