What is an Annuity and Why Would I Buy One?

financially savvy kids

By K. Bridget Schneider, CFP®, CRPC®
annuity

Have you heard that June is Annuity Awareness Month?  I can imagine some of you saying, “No, but I hear that annuities are expensive and lock up your money with little to nothing paid out as you get older.”  Well, that misperception is why I want to discuss what an annuity is and why you might buy one. 

What is an Annuity?

There are three main types of annuities.

  1. Fixed Annuities will provide a fixed rate of interest based on the terms of your contract. If you’re interested in safety and not comfortable with market risk, you may want to consider a fixed annuity.
  2. Fixed Indexed Annuities offer a crediting strategy based on an underlying market index, i.e., Standard & Poor’s 500. These may offer some protection from market downturns but a cap on the credit percentage for a given period. This type of annuity may be right for you if you’re looking for market-based growth but want to lessen any potential downturns in the market.
  3. Variable Annuities offer market-based investment options. With this type of annuity, you need to be comfortable with the ups and downs of market performance because your account value will fluctuate depending on market performance.  If you’re looking for higher growth potential and a broader range of investment options, a variable annuity may be right for you.

Annuities can be purchased with either a single investment or with flexible periodic investments.  Sometimes you will hear the investment called a premium.  That term probably reminds you of insurance.  That’s because an annuity is a long-term, tax-deferred contract between you and the insurance company that can provide a fixed or variable stream of income during your retirement.

Why Would You Buy an Annuity?

Protect Your Investments from Loss

Depending on the type of annuity you choose, you can protect your investment from loss during market downturns.  This can be helpful for someone who will need to use the funds in the near future or for those who want to leave a minimum amount to their beneficiaries.

Tax-Deferred Growth

You don’t pay taxes on annuity growth until you withdraw it.  This feature allows all your interest or investment earnings to compound, which may help the investment grow faster.  However, you should know that while there may be other reasons to purchase an annuity in an IRA or other tax-deferred account, you won’t get any additional tax advantage.  Since the earnings and income in these accounts are already tax deferred, you should consider an annuity for its features and benefits other than tax deferral.

No Annual Contribution Limits

Annuities don’t have annual contribution limits.  So if you’re already maximizing contributions to your 401(k) and IRAs, and you want more tax-deferred investments, an annuity is an option.  This could also be helpful to those getting a late start on saving for retirement.

Guaranteed Income for Longevity

None of us know how long we will live, so it’s difficult to calculate how much money we need to last our lifetime.  If you have saved for your retirement but are concerned that you might outlive your retirement savings, an annuity may provide a solution.  Annuities can provide an income stream through annuitization or a guaranteed income benefit rider.  Some of these options include lifetime income streams, which can provide some peace of mind that your income can continue for the rest of your life.

Summary

Now you know not only what an annuity is, but why you might buy one.  Annuities provide a range of benefits and features that may help you achieve a variety of goals.  However, it is important to address your specific needs and preferences. 

If you would like to discuss whether an annuity is right for you, Connections Financial Advisors can help.  We want to be your friendly financial guide and ally.  Be sure to visit our website today or call us at 217-605-8130. Our mission is to help you make more informed decisions to better your financial position and reduce your financial stress. 

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual, nor intended to be a substitute for specific individualized tax or legal advice.  The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

Traditional IRA account owners should consider the tax ramifications, age, and income restrictions regarding executing a conversion from a Traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation.

Riders are additional guarantee options that are available to an annuity or life insurance contract holder. While some riders are part of an existing contract, many others may carry additional fees, charges and restrictions, and the policy holder should review their contract carefully before purchasing. Guarantees are based on the claims paying ability of the issuing insurance company.

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