What Are Annuities and Are They Good Investments?

If you aren't familiar or just a little fuzzy on how annuities work and what they are; an annuity is a long term investment that is issued by an insurance company designed to help protect you from the risk of outliving your income. You invest a lump sum (sometimes a nest egg or savings) or invest over a period of time. You can then start receiving payments immediately or at some later date depending on how your specific annuity is structured based on your age, goals and plans for retirement.

Many people use annuities to supplement retirement accounts. Annuities, unlike retirement accounts, give you a fix rate of return (FRR). For example: You invest in an annuity and are given a FRR of 7%. The stock market gives your annuity an average of 10% year one, you get 7%. However, year two the stock market gives your annuity a return of 4% - you still get 7%. The downside of your investment is protected. At the same time, any upside of the investment is neutralized by the fixed rate you are given by the issuing insurance company.

These investment vehicles are one of the safest and with the most guaranteed interest rates available to investors today.

Tax-deferred annuities: for retirement savings

Deferred annuities can be a good way to boost your retirement savings once you've made the maximum allowable contributions to your 401(k) or IRA.1 Like any tax-deferred investment, earnings compound over time, providing growth opportunities that taxable accounts lack.

Deferred annuities have no IRS contribution limits,2 so you can invest as much as you want for retirement. You can also use your savings to create a guaranteed3 stream of income for retirement. Depending on how annuities are funded, they may not have minimum required distributions (MRDs).

Bear in mind that withdrawals of taxable amounts from an annuity are subject to ordinary income tax, and, if taken before age 59?, may be subject to a 10% IRS penalty. Annuities also come with annual charges not found in mutual funds, which will affect your returns.

Deferred variable annuities have funds that may have the potential for investment growth. However, this can involve some market risk and could result in losses if the value of the underlying investments falls. Variable annuities are usually appropriate for those with longer time horizons or those who are better able to handle market fluctuations. Some variable annuities allow you to protect your investment against loss, while still participating in potential market growth.

Deferred fixed annuities offer a guaranteed3 rate of return for a number of years. Fixed deferred annuities may be more suitable for conservative investors or for those interested in protecting assets from market volatility. In this way, they’re similar to certificates of deposit (CDs).

However, deferred fixed annuities differ from CDs in that:

• Annuities are not FDIC-insured.
• Withdrawals from annuities prior to age 59? may be subject to a 10% IRS penalty.
• Deferred fixed annuities may offer more access to assets than a CD.
• Annuity earnings compound on a tax-deferred basis.

Income annuities: for income in retirement

Income annuities may be appropriate for investors in or near retirement because they offer guaranteed3 income for life or a set period of time. They may allow you to be more aggressive with other investments in your portfolio, since they provide a lifetime income stream.

Keep in mind that you may have limited or no access to the assets used to purchase income annuities.

Immediate fixed income annuities offer a guaranteed,3 predictable payment for life, or for a certain period of time. Your guaranteed income payment cannot be affected by market volatility, helping shield your retirement income from market risk.

A cost-of-living increase is available at an additional cost to help your buying power keep pace with inflation.

Deferred income annuities4 are fixed income annuities that have a deferral period before income payments start. Because of the deferral period, you may get a higher income payment amount than you would from a comparable immediate fixed income annuity with the same initial investment. The cost-of-living increase is also available at an additional cost for deferred income annuities.

Interesting Facts About Annuities

• Annuities originated in Roman times when citizens would make a one-time payment in exchange for lifetime payments made once a year.
• The word annuity is derived from the Latin word “annus”, which means year.
• If you win the lottery, you will choose how to be paid: Cash (a one-time, lump-sum payment) or an Annuity (one immediate payment followed by 26 annual payments).
• If you take the “Annuity” payout, for every $1 million in the jackpot, you will receive approximately $385,000 per year before taxes.

Ref: Fidelity Investments / Napkin Finance