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Retirement savings can be a challenging endeavor. But, as soon as you determine how much money you must save for retirement, that’s when the real planning can get underway.
Retirement savings options include 401(k) plans through employers, individual retirement accounts (IRAs), and Social Security. However, there are also the misunderstood and underutilized annuities.
Although annuities can supplement your retirement income, there is no guarantee that they will work for you. What’s more, annuities can be complex and expensive. Thankfully, the team of experts at Due can assist you in deciding whether or not an annuity is right for you. We do this through unbiased and easy-to-understand articles and guides to answer the most common annuity questions, such as the following.
What is an Annuity and How Can it Help Me in Retirement?
The term “annuity” refers to a contract between you and an insurer. As a policyholder, you either pay a lump sum of money to the insurance company or pay it in installments over time. Upon receiving those funds, the insurance company invests them so that you’ll receive a series of guaranteed payments.
As compared to other insurance contracts, the payments aren’t conditional upon an unfortunate occurrence. Instead of making a claim, the customer decides how their payouts will be made. Usually, this is at a later date, like 20-years from now. But, you also have the option to receive payments much sooner.
Retirement portfolios can benefit greatly from annuities, as they can provide the following;
- Protection and growth. Investing in an annuity allows you to grow your money without putting it at risk.
- Tax-deferral. As long as the annuity payments are not received, you are not subject to taxes.
- Long-term security. Some insurers offer a long-term care annuity to cover future long-term care costs, while also providing a supplemental retirement income.
- Inflation adjustments. You’re likely to earn a return that’s either at or above inflation if you purchase an inflation-protected annuity (IPA).
- Death benefits for heirs. You can pass on your annuity balance to heirs or spouses with an annuity that allows death benefit riders.
Additionally, research shows that retirees with a guaranteed income are happier and live longer.
Different Types of Annuities
Annuities come in all sorts of different shapes and sizes. However, these are the five most common annuity types you can choose from.
- Fixed annuities. A fixed interest rate is applied to annuities for a defined period of time. As an example, Due rewards its users with 3% on everything they deposit. Therefore, this type is similar to a certificate of deposit. This is an option that’s safe and predictable, regardless of the performance of the market.
- Variable annuities. The returns of a variable annuity fluctuate with the market, unlike a fixed annuity. As a result, it’s riskier and less predictable as it’s based on performance.
- Fixed indexed annuities. Combining both variable and fixed annuities, this type of annuity has many advantages. The principal is protected by the minimum guaranteed rate of return, like a fixed annuity. In addition, it follows an underlying index, such as the S&P 500). As a result, it can gain more when the stock market rises. A number of factors affect the upside, such as caps, spreads, and participation rates, so read the fine print carefully.
- Immediate annuities. In this case, you would pay a lump sum to the insurance company and start receiving income payments right away. Usually, income payments begin within thirty days after payment. In some annuities, lifelong payments are offered, while in others, payments are spread out over a set period. The interest rate affects income from annuities, so the payout is likely to be affected as well.
- Deferred annuities. You will also make an upfront payment with this type of annuity. Payments, however, won’t be issued until a future date. Because deferred annuities have more time to grow, the payouts may be higher than those from immediate annuities. The downside is that early withdrawals are difficult.
How Much Does an Annuity Cost?
The price of an annuity depends on the kind you choose. You should know, though, that annuities don’t come cheap, regardless of their type. Despite this, payout annuities and fixed indexed annuities charge no specific fees. And, in general, fixed-rate annuities carry lower fees than variable-rate annuities.
In light of this, why are annuities so expensive? The primary reason may be commission fees.
Most annuity contracts fail to clearly state whether commission fees are included. The fees can nonetheless range from 1% to 10% of the contract value. Additionally, the timing of payments depends on the structure of your annuity.
- Commissions for single-premium annuities often range from 1% to 3%.
- Typical rates for deferred income annuities are 2% to 4%.
- On a 10-year fixed annuity, commissions typically range from 6% to 8%.
In addition to commissions, you may also need to consider the following fees;
- Riders are customized features that can be added. Common riders include death benefits and minimum payouts. The annual cost of each rider usually ranges between 0.25 and 1%.
- An administrator’s fee is the fee you pay to manage your annuity, usually about 0.3% of its value. In some cases, a flat fee of $30 may be charged.
- You are charged a mortality expense risk charge based on a certain percentage of your account value, typically 1.25%. This fee is to compensate the insurance company for taking a risk in selling you the annuity contract.
- An underlying fund’s expenses include any management costs associated with the mutual fund itself.
- Unless you reach a certain age, usually 59 ½, before selling or withdrawing your annuity, a surrender charge and a tax penalty may apply.
How Are Annuities Taxed?
Annuities are tax-deferred investments. As a result, you do not have to pay taxes on the funds while they are in the annuity. Just like a 401(k) or an IRA, that means you don’t pay taxes until you begin withdrawing money.
Ordinary income tax is taxed on annuities funded with pretax dollars or qualified annuities. As a result, you’ll be taxed on every withdrawal. A non-qualified annuity is one that is funded with after-tax dollars. This means you won’t owe taxes on your original principal withdrawal. Taxes will be due on your earnings.
The exclusion ratio determines which portions of earnings and principal of your withdrawals belong to non-qualified annuities. As a result of the exclusion ratio, your principal return will decrease over the course of your actuarial life.