Annuity meaning | Retirement annuity meaning | What is retirement annuity?
An annuity is an insurance product designed to provide regular disbursement of a certain amount starting immediately or in the future. The amount is paid against the accumulated sum, which is collected in the form of regular payment/lumpsum payment as per the contract.
Type of Annuity
Fixed: Company offers fixed periodic payments, this is risk-free and guaranteed return with a minimum interest rate generally 1% to 3%.
Variable: Advertised as it can provide a higher return than fixed and indexed annuity plan but have a higher risk, you may lose money.
Indexed: It is a combination of insurance and index, based on how the index is performed along with parameters like participation rate (how much increase in the index will be used to calculate interest) rate cap, margin, spread, and administrative charges.
Accumulation Phase
- Deferred Annuity: Accumulation is done through fixed periodic payment there can be a flexible payment option.
- Immediate Annuity: Also known as Single Premium Immediate Annuity (SPIA) as per name when someone inherits money or sold a house or wins a lottery then he/she can use part of the money to get an annuity plan for regular income and to avoid spending temptation.
Payout phase
Life only: Payment is done as long as you live not paid to your beneficiary.
Fixed amount option: Fixed amount is paid as mentioned in the agreement.
Life option with a period certain: You get paid and your beneficiary gets payment after you for the period mentioned in the contract.
Joint and survivor life option. Payment is done to you and after you to your beneficiary as long as either is alive.
Generally, the payment amount differs depending on the payout option you choose
Surrender Charges
The company charges a penalty if you withdraw or surrender, it is high in the initial years before age 59½. IRS charges a 10% penalty if you withdraw before age 59 ½.
If your contract has a free withdrawal option you can withdraw 10% of accumulated value every year without paying surrender charges. Withdrawal amount is not tax-free you might have to pay tax and IRS penalty for early withdrawal.
1035 exchange
IRS Section 1035 allows changing a permanent life insurance policy into an annuity contract without paying any tax.
A must check before buying annuity
- Surrender fees and charges and its period.
- Do not check with only one company, premiums and benefits differ from company to company.
- Compare plans of different companies on the below parameters
- How you will be paid by the company
- Maturity date
- Guaranteed minimum interest rate
- Current interest rate
- Surrender period and charges
- Fees, costs
- Availability of free withdrawal option
- Can annuity be in loss
- After my death, can annuity pay to my beneficiary, and in what amount?
Which annuity one should buy?
The objective is to get maximum return and assurance to get expected or projected return but many fails.
Choose the plan which do not eat your earned interest, one should choose which has less cost and fees, and admin charges.
Index and variable Annuity have a lot of maintenance charges.
Choose a less costly plan, a company that has less maintenance and operating charges should be considered.
Buy an Annuity plan only when you need constant income and you want to pass on a regular income to your beneficiary after you die.
Inform a trusted family member or beneficiary about annuity you buy.
Buy Annuity when you have no other option to invest.
Remember it is difficult to get out of the plan without charges which will incur a loss.
You can sell your Annuity just like life insurance
Check your agent or broker’s authenticity at FINRA brokercheck.finra.org.
Annuity Vs 401K
Main difference between an annuity and 401 K plan
| Annuity | 401K Plan |
| Anybody can buy annuity | Employee whose employer has 401K can only contribute |
| No limit on contribution. | Contribution has a yearly limit |
| Agent earns commission for selling annuity | Employer earns no commission |
| High maintenance charges, extra fees for riders | Low maintenance charges |
| Funds are locked and cannot withdraw without charges. It has higher surrender charges and longer surrender period. | You can take out fund and return in specified time and can avoid charges. |
| 1035 exchange possible to other insurance product, no exchange to IRA | Roll over possible to other IRA, Roth IRA. |
Disadvantages of an annuity | What are the advantages and disadvantages of annuities
Buying an insurance product is a big decision when you are investing your saving, studying about the product will help you understand whether you are buying the right product or not.
Money invested in annuity is blocked for life, taking out money is not easy. Annuity contract is different from other products it is designed to provide lifetime income.
Taking out funds attract taxes plus penalty and other charges, you might lose more than your gain.
Growth is capped, funds in annuity do not grow at the same rate as the index when the index or stocks are doing well. On the other hand, when the index is not doing well you may lose all your funds.
It has high admirative charges which makes it milking cow for the insurance company, not for you.
Indexed and variable annuity are sold on high commission, and has got bad reputation.
Many people believe that annuities are bad investment as you do not earn much interest they believe in other investment option which do not block money for long.
Even employer’s pension plan is better option than SPIA (single premium immediate annuity).
You may lose you investment if insurance company goes bankrupt.
State of Florida had to bring legislation to protect citizens from annuity sales, it was originally meant for seniors.
Advantages It provides constant source of income, and you can avoid spending temptation, only SPIA with low cost is recommended to buy.
What is better than an annuity for retirement
Other Options for retirement
- Certificates of Deposit
- IRA
- Roth IRA
- HAS
- HRA
Annuity awareness month
Month of June is National Annuity Awareness Month (NAAM), to help Americans educate about Annuity.