There are two basic types of annuities, immediate or deferred. The main difference between them is when you want to begin receiving payments. And, that really depends on your specific financial goals.
To help you pick the option that aligns best with your goals, here’s a closer look at immediate and deferred annuities.
As you probably correctly assumed, with immediate annuities you can start receiving payments soon after you make your initial investment. The pros of this type of annuity include:
- Protection against outliving your savings.
- Being allowed to add your spouse so that they’ll continue to receive payouts after you pass.
- It has a simple structure that makes it easier to understand and plan your retirement.
- Your savings are protected from the market since your savings actually aren’t in the market.
- Provides you with a pre-determined revenue stream since these are more like paychecks as opposed to savings.
There are some drawbacks as well. Mainly, they won’t grow with any market upside making it not viable if you’re looking to invest. Moreover, immediate annuities aren’t flexible and you don’t have as much control over withdrawals.
With a deferred annuity, you’re investing your money and then taking it out at a later date. In other words, you’re paying a premium to the annuity. You then choose from the available investment options.
After you’ve settled on your investment option, your earnings will accumulate on a tax-deferred basis. And, unlike immediate annuities, you have much more flexibility. In fact, you can determine when to start the distribution, income, and phase at a later date — this is usually around when you retire.
Now, before you impulsively purchase a deferred annuity, you need to be aware of the fact there are actually three types of deferred annuities.
These provide you with a fixed rate of return. The catch? It’s only for a specified period of time. However, you select that timeframe. Ideally, it should be one based on how much you need during retirement and your income needs.
Variable annuities come with a plethora of professionally managed investment options. Because of this, the value of the annuity contract is determined by the performance of the underlying investment options (also called sub-accounts) that you chose. That also means they can fluctuate. Additionally, you can add-on an optional living benefit rider — for an additional cost of course. It provides a guaranteed lifetime income, no matter how the annuity’s investments are fairing.
Indexed annuities are considered a better option if you’re seeking investment growth. In this case, through any returns associated with the performance of market indices, such as the S&P 500. Note that this will take place over a variety of time-horizons and provides 100% principal protection from the insurance company. However, gains linked to the annuity are capped in order to offset this protection. As a consequence, growth may be less than what the actual market gains were achieved by the index. Fixed indexed annuities are also similar to variable annuities in that you have the option to throw-in lifetime income benefits.
Also, you can convert your deferred annuities into immediate annuities — if you are in need of cash right now. Furthermore, both can be either fixed or variable. And, they each come with fees and expenses. That means payouts made from your contributions will have those costs subtracted.