What is an Annuity?

An annuity is a long-term savings plan that can be used to accumulate assets on a tax-deferred basis for retirement and/or to convert retirement assets into a stream of income.

Fixed Tax-deferred annuities: for retirement savings

Fixed deferred annuities have no IRS contribution limits, so you can invest as much as you want for retirement. You can also use your savings to create a guaranteed stream of income for retirement.

A fixed deferred annuity has two distinct phases: the accumulation or savings phase and the income phase.

During the accumulation or savings phase, annuity premiums, less any applicable charges, accumulate in the contract on a tax-deferred basis until contract maturity. Deferral of tax on annuity earnings is a major advantage that other nonqualified financial products cannot provide. During the accumulation phase at any time within contract provisions an individual can decide to enter the income phase and trigger an income stream for the rest of their life or a set period of time.

Deferred annuities can be a good way to boost your retirement savings. Like any tax-deferred investment, earnings compound over time, providing growth opportunities that taxable accounts lack.

Fixed deferred annuities typically fall into two categories; fixed interest annuities and fixed indexed annuities.

Fixed Interest Annuities

A fixed interest annuity pays a fixed rate of interest on the premiums invested in the contract, less any applicable charges. The insurance company guarantees* that it will pay a minimum interest rate for the life of the annuity contract. A company may also pay an “excess” or bonus interest rate, which is guaranteed* for a shorter period, such as one year.

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Indexed Annuities

An indexed annuity has characteristics of both a fixed interest annuity and a variable annuity. Similar to a variable annuity, the insurance company pays a rate of return on annuity premiums that is tied to a stock market index, such as the Standard & Poor’s 500 Composite Stock Price Index. Similar to fixed interest annuities, indexed annuities also provide a minimum guaranteed interest rate*, meaning that they have less market risk than variable annuities. An investment in an indexed annuity is not a stock market investment.

Instead, the rate of return is linked to the performance of a market index that tracks the performance of a specific group of stocks. Since the minimum guaranteed interest rate is combined with this interest rate linked to a market index, indexed annuities have the potential to earn returns better than fixed interest annuities when the stock market is rising. In addition to the minimum guaranteed interest rate a fixed index annuity also has a floor which means when the stock market has a negative return the funds inside of a fixed index annuity will have a zero return less applicable fees etc.

Bear in mind that withdrawals of taxable amounts from an annuity are subject to ordinary income tax, and, if taken before age 59½, may be subject to a 10% IRS penalty.

Income annuities: for income in retirement

A single premium immediate annuity has only one phase: the income phase.The single premium used to purchase an immediate annuity is converted into a stream of income immediately or shortly after the date the annuity is purchased. Single premium immediate annuities offer a variety of income options to meet various needs. Keep in mind that you may have limited or no access to the assets used to purchase income annuities.