An annuity is an exciting option for seniors and investors as they provide a steady stream of income as long as you live. If you meet an insurance agent, they will probably define annuity as an income stream outliving you. There is some iota of truth in this as an annuity can serve you as long as you are alive or even outlive you.
This is appealing when you consider it on the surface. This, however, does not explain everything annuity entails. You are in a better position to shop for an annuity when you know annuity and what it involves.
What is an Annuity?
An annuity is an agreement between you and the insurance company to take care of definite goals like lifetime income, principal income, or medical expenses. They are not investments but contracts between you and the insurance company.
The Great Depression of the U.S. made annuity universal when people were concerned about stock market volatility on their retirement. Pension plans are gradually fading out with many retirees considering an annuity, and a means to have a stream of income.
Why Should You Buy an Annuity?
An annuity can give you what other investments will not – a stable income source for as long as you are alive. This is one of the reasons why many people are considering an annuity. With an annuity, you can save for retirement and enjoy some tax protections if you have maxed out your IRA and 401(K). Also, there is no contribution cap hence no limitation on what you can save.
Annuity: How it Works
With an annuity, the risk goes from the owner (the annuitant) to the insurance company. With other insurance types, what you pay the insurance company (annuity) is what they use to mitigate the risk. The premium can be a series of payments of a lump sum, depending on the annuity's nature.
Annuity premium stands out from other types of insurance in that you do not need to pay indefinitely. In time, you stop paying the annuity and the annuity will pay you. This is when your contract enters the payout stage.
Annuity payment is not in any way rigid. You can structure it to give out payment in a fixed number of years to you or your loved ones as long as you live. It could go on till you and your spouse pass away, and it could also involve lifetime income alongside a guaranteed "period certain" payout.
Getting a "life with a period certain annuity," you will be paid for life. Should you, the beneficiary, die during the period, the annuity payment will go to your recipient to exhaust your amount. This is a factor of the contractual period available on your application.
Like Social Security, annuity income streams are factors of the beneficiary's life expectancy, giving you smaller payments for an extended period. With this, if you were very small when you started getting the income, you will have a long life expectancy. In the same way, the longer the period-specific term is, the lower the payment to expect.
You can have your payment every month, quarterly, or annually. It can even be a lump sum. You can have it immediately or postpone it for years.
Early Withdrawal Might have Penalties.
There are surrender charges if you withdraw your money early, like with CDs and MYGAs. The surrender period could be two or ten years. The costs, however, reduce with time. For instance, a deferred annuity with a 5-year surrender plan will charge 5% on what was withdrawn in the first year, 4 percent for the second year, etc.
The good news, however, is that almost all companies let you access the interest. Also, many companies will make you access 10% of your original premium after 12 months.
Annuity and taxes
You do not have to pay taxes on the money in an annuity, meaning they are tax-deferred. The tax comes in only when withdrawn like IRA or a 401(K).
Funding your annuity with the pretax dollar will make the tax on everything you withdraw at your ordinary income tax. This is called a qualified annuity. There is, however, nonqualified annuity as well, which involves using the after-tax dollar. There will not be a tax on the portion of the withdrawal that is a part of your principal. They will only tax your earning in a nonqualified annuity.
