We help many people with annuities at Funeral Funds of America. Annuities are not for everyone, so our recommendations are always specific to your situation and needs.
What Is An Annuity?
An annuity is a financial product that pays guaranteed income stream or lump-sum payment in retirement. It is a contract between an individual and a provider company for retirement planning. The goal of annuity is to ease the fear of outliving your assets.
There are three parties to an annuity:
- Owner – Annuity owner can be a person or an entity that can buy and fund annuities. They can also pay the premium, change beneficiary, withdraw money, surrender the contract, and make changes before annuitizing the contract.
- Annuitant – A person not an entity who is insured. Annuitants can differ from the contract owner, but they can be the same in most cases. The annuitant’s life determines how long the payment will be made.
- Beneficiary – The recipient of annuity proceeds when the annuitant passes away. A person or an entity can be a beneficiary.
Social Security, defined benefit pensions, and lottery prize payouts are examples of annuities that pay retirees’ income for life, or for a set period with a lottery payout.
Annuity is illiquid and subject to withdrawal penalties. It is not recommended for younger people or those who will need immediate funds in the future.
Why Buy Annuities?
Buying an annuity can help manage your income in retirement. The benefits of annuities include:
- Peace of mind and the thought that you will not have to worry about running out of money during retirement.
- Steady stream of income for the rest of your life, or the life of your spouse.
- Supplemental income to your pension or Social Security benefit.
- Receive death benefit. If you pass away before your distribution phase, your beneficiary will receive the payment.
- You pay no taxes on income from your annuity until you withdraw the money.
Annuities Pros & Cons
- Annuities are the best tool for retirement planning.
- Annuities provide a source of income you cannot outlive.
- Annuities provide a guaranteed fixed income for the rest of your life.
- Annuities offer death benefits like life insurance with no underwriting. Death benefit payout avoids probate.
- Some annuities won’t let you lose money to market volatility.
- It can grow retirement savings faster with triple compounding.
- Some annuities can help pay for long-term care expenses (nursing home, home health care, assisted living, and adult daycare).
- Some annuity types offer higher fixed interest rates than a certificate of deposit, and it does not pay annual taxes.
- Annuities are long-term investments. You cannot access your funds immediately without paying penalties.
- Limited liquidity: you can only access a percentage of your contract value each year until the contract expires.
- You cannot turn off your income stream once you start annuitizing.
- Some annuity types depend on market performance.
- You may lose money due to stock market volatility in case of index linked annuity contracts.
- The FDIC does not insure Annuities.
How Do Annuities Work?
Annuities are financial products that pay guaranteed income or lump sum for retirees. During the accumulation phase, you can buy an annuity from the insurance company or financial provider with a single payment or series of payments.
During the distribution phase, the financial provider sends multiple payments or a lump sum for a specified time or for the rest of your life.
There are different annuities depending on your needs and risk level. Annuities can be structured as fixed or variable. You can also purchase riders to change or customize your annuity.
Annuities have a surrender period which spans several years. During this period, you cannot make withdrawal without paying a surrender charge or fee.
Many financial providers may allow you to withdraw up to 10% of your account value without paying a surrender fee. Withdrawing more than that will make you pay a penalty even after the surrender period lapsed. There are also some tax implications if you withdraw before age 59 and a half.
If you want to avoid the surrender fee, you can opt to sell your annuity for a lump sum and exchange your right for future annuity payments.
When you die, the financial provider will provide the rest of the cash value to your beneficiary.
Debunking Annuity Myths
I Can Lose Money – Your money is not at risk of stock market volatility. Not in every type of annuity. It only happens if you have a variable or registered linked annuity.
Hidden Fees – Fees are built in the contract when you sign it. Your charges depend on the type of policy you have. Surrender charges are enforced during the surrender charge period.
Annuities Are Complicated – Annuities are simple. They are designed more like a pension or Social Security benefits; they provide lifetime income.
No Money For Beneficiaries – Beneficiaries receive the remaining cash surrender value of the account. This benefit avoids probate.
No Liquidity – Most policies allow penalty-free withdrawals after one year. There are also systemic withdrawals and waivers to assist in health-related issues.
You Pay Fees To Buy An Annuity – You do not pay a fee to the agent when you buy an annuity. They are compensated by the financial provider through commissions when selling annuities.
Annuities Vs. Life Insurance
Annuities and life insurance are different in function:
- Life insurance is death protection and protects against premature or unexpected death.
- Annuities are used for retirement and protect against longevity risk and running out of money.
Life insurance benefits are given after death while annuities income are distributed while the contract owner is still alive.
What Are The Different Annuities?
There are different annuities:
- Immediate Annuity – The annuitant pays a lump sum of money for an immediate stream of income. A single premium immediate annuity pays income 1 to12 months after payment.
- Deferred Income Annuity – The contract owner pays a lump sum of money and it delayed the income payment until a future date, typically greater than one year.
- Fixed Annuity – This type of annuity provides a fixed interest rate for a specific period in the amount specified in the contract.
- Fixed Indexed Annuity – Allows the contract owner to take part in the stock market while providing protection from market volatility. Contract owners earn market gains without downside.
- Variable Annuity – They designed this annuity type for people that can tolerate higher risk. Contract owners can participate in investments like stocks, bonds, and mutual funds. However, they get both the upside and the downside potential of this product. The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) regulate annuities. Agents or brokers offering annuities must have a state-issued life insurance license and securities license when selling variable annuities.
Annuity riders are additional benefits you can add to the retirement plan:
- Income Rider – also called Guaranteed Lifetime Withdrawal Benefit, is an add on that provides steady retirement income for life.
- Return of Premium – allows the contract owner to terminate the current contract without surrender charges and receive the original investment back minus fees and withdrawals.
- Enhanced Death Benefit Rider – serves as an alternative to life insurance without the medical underwriting. It delivers a bigger benefit than the accumulated value to the policyholder’s heirs.
- Nursing Home Waiver – waives the surrender charges if the contract owner is admitted to a nursing home.
- Accumulated Penalty-Free Withdrawals – unused penalty-free withdrawals that are rolled over to the next year. It increased the contract owner’s penalty-free liquidity until the income withdrawal.
- Spousal Continuation – surviving spouse can continue the contract for the rest of the initial term instead of getting the lump sum of the account value.
- Terminal Illness Waiver – Waives the surrender charge during the surrender period if the contract owner is diagnosed with terminal illness and expected to die within 12 months.
- Cost of Living Adjustment (COLA) – Rider that inflation proof the policy guaranteeing an increasing stream of income in retirement.
Make sure you understand any potential fees and charges before buying any annuity:
- Surrender Charges – The average surrender charge period is seven years. You will pay this fee if you cancel or cash out your policy early. This fee is highest during the early years and reduced over time. Surrender charges are typically 5 to 25% of the amount withdrawn.
- Mortality Expenses – Financial providers charge this fee to provide death benefits on the contract. Mortality expenses are about 1.25% of your account value. You need to pay this fee annually.
- Administrative Expenses – Financial providers may charge you for record keeping, cost of mailings, and other administrative services.
- Riders – You will pay an additional cost to add features and customize your policy.
- Investment-Expense Ratio – For variable annuities, pay annual investment management fee for your stock or bond account.
- Fees and Charges or Other Features – You will pay fees for guaranteed minimum income benefit or long-term care insurance. You will also pay fees if you transfer part of your account from one option to another.
- Penalties – You may need to pay a 10% tax penalty to the IRS if you withdraw money from your annuity before the age of 59 ½ on top of taxes you owe on the income.