An annuity is one of many forms of retirement investing. It can seem like a fairly complicated investment, but when broken down to its simplest form, annuities are relatively easy to understand. Before investing in any savings plan, it is important to carefully evaluate your options to determine what will meet your individual financial goals.
An annuity payment, or premium, is the dollars the investor pays into the annuity, almost like depositing money into a bank. An annuity purchase is basically like purchasing an insurance policy.
Variable and fixed annuities have many of the same retirement benefits as a 401(k) or IRA, however annuities do not have contribution limits, income limits or mandatory withdrawals like other retirement plans. Since after-tax dollars are used to purchase the annuity, the earnings grow tax-free.
How does an annuity premium work?
The premium you pay into an annuity is an investment. Often, an annuity purchase is one payment, instead of a monthly premium like a life insurance policy. If you want to invest $15,000, you make one annuity payment of $15,000 up front. If you want to continually pay into your annuity, you may have a surrender period that must be completed before you can pay in additional dollars.
An Annuity sales amount depends greatly on the type of annuity you invested in. If you invested in a fixed annuity, your money grows based on a pre-determined rate which is guaranteed for a specific amount of time. The annuity rate and term will be specified in your contract. One of the advantages of a fixed annuity is that you can easily calculate how much money you will earn if you decide to sell the annuity by using an annuity table.
If you invest in a variable annuity, the amount of money you paid in is then invested in stocks, bonds, and money market accounts, much like a 401(k) plan or a traditional IRA. Purchasers of this type of annuity can select the funds where their money will be invested. The annuity rate, or amount paid out, is determined by the performance of the selected investment option.
Since an annuity is a contract between a buyer and an insurance company, with the contract, the insurance company promises to invest the buyer’s money well and pay it back out over a specified number amount of time.
Some of the advantages of an annuity are:
- Tax-deferred growth and compounding
- Guaranteed rate of return on your investment
- Option of guaranteed lifetime payments
A few of the disadvantages of annuities are:
- You may have to pay for the guarantee an annuity offers.
- The contract may have a surrender period before you can sell the annuity.
- There are some IRS rules restricting how your money is paid out, depending on your individual contract.
When deciding if an annuity is the right investment for you, you should always carefully research your options and determine what would be the best type of annuity for you to invest in. Annuities are a good option for consumers who may have maxed out their IRA contributions or 401(k), or have exceeded the income limit for contributing to a Roth IRA. Numerous online websites provide simple and effective insurance quotes to help you find competitive rates.