Guaranteed income for life
July 24, 2018
If you have life insurance, you’ve taken a wise and important step in securing your loved ones. But life insurance is only one side of the coin. You’ve prepared your loved ones for the unexpected, but have you adequately prepared for your own financial future?
Annuities can provide stability for retirement while offering tax-deferred growth in the meantime. Best of all, you can enjoy the benefits of your prudence while you’re still living. In this article, we’ll take a look at how annuities play a role in your financial plan and explore different types of annuities.
What is an annuity?
It’s easiest to think of an annuity as complementary to life insurance. If you die prematurely, life insurance provides a financial resource for your beneficiaries. Conversely, if you outlive your resources, an annuity can provide supplemental income for the rest of your life.
At its core, an annuity is a retirement savings plan that provides tax-deferred growth and guaranteed income. It can be a supplement to an employer-sponsored retirement plan or take the place of one entirely. An annuity owner (also known as an annuitant) can contribute to an annuity on a regular basis or fund it with a lump sum, like a 401(k) rollover or inheritance.
There are two phases to an annuity: the accumulation phase and the income phase.
1. The accumulation phase
During the accumulation phase, an annuity increases in value through interest and premium contributions. The amount of interest earned is determined by many factors, such as bond and market performance and the annuity’s total value. Over time, small contributions to an annuity build momentum and can grow into a healthy nest egg. A licensed agent can help you determine how much to contribute based on your long-term goals.
[Call-out quote:]If you outlive your resources, an annuity can provide supplemental income for the rest of your life.
2. The income phase
When an annuitant is ready, he or she can turn the annuity into a steady stream of guaranteed income, usually at or near retirement. This process is called annuitization. The annuitant decides how often to receive payments (monthly, annually, etc.) and how long to receive them (for life, for a specific period of time, for a spouse’s life, etc.). These decisions, along with the total account value, determine how much income the annuity will generate. If an annuitant dies before reaching the income phase, under current tax law the annuity’s value goes to a designated beneficiary without probate.
Types of annuities
Fixed-deferred annuities
When you purchase a fixed-deferred annuity, it will earn the declared first-year interest rate during its first 12 months. After that, it will earn a renewal rate, which may increase or decrease from year to year but will never fall below the guaranteed minimum interest rate. The annuity grows tax-deferred during the accumulation phase without the risk of losing value. Fixed-deferred annuities can be flexible-premium (allowing for multiple deposits during the accumulation phase) or single-premium (funded with a lump sum without subsequent deposits).
Multi-year guarantee annuities (MYGAs)
A MYGA is a specific type of fixed-deferred annuity that earns the declared interest rate for several years, typically between three and seven. After that, the MYGA will earn a renewal rate with a guaranteed minimum. MYGAs are typically single-premium.
Immediate annuities
Immediate annuities skip the accumulation phase and begin producing income right away. A competitive current accumulation rate is factored into the income payments. Because there is no accumulation phase, immediate annuities are single-premium.
Indexed annuities
Indexed annuities have the potential for greater long-term growth because the interest rate follows the movement of an external stock index. The interest rate is subject to certain factors, such as participation rates and cap rates, which are declared in advance. The guaranteed minimum is called a floor rate and is generally much lower than the guaranteed minimum featured on a fixed-deferred annuity, sometimes as low as zero percent. Despite this, indexed annuities do not lose value when markets perform poorly. Indexed annuities can be flexible- or single-premium.
Variable annuities
Unlike indexed annuities, variable annuities invest their value into equity and bond subaccounts. This can allow for high returns, but the annuity can also lose value, presenting greater risk than other types of annuities. When annuitized, income payments can vary based on market performance. Variable annuities often feature a guaranteed death benefit to help mitigate their risk. They can be flexible- or single-premium.