Is An Annuity Right For You?

Everybody knows about the advantages of a checking or savings account, or even how to buy a certificate of deposit. However, if you ask them what an annuity is, you will probably get some shrugs.

What Is An Annuity?

For those in the dark, an annuity is an insurance contract that guarantees you won’t run out of money in your retirement. An individual agrees to pay either a lump sum or make periodic payments into an interest-bearing account in exchange for a guaranteed payment at an agreed-upon future date. An annuity can provide a steady stream of income for life.

There are two basic types of annuities – immediate and deferred. While the former allows you to begin receiving payments immediately after paying for your annuity, the latter delays these payments for a predetermined period of time.

The Advantages Of An Annuity

Perhaps the most obvious benefit of an annuity is the peace of mind an annuity offers its holders. Annuities are relatively conservative investment vehicles that can guarantee a set stream of income for life for the investor – at minimal risk. Your earnings are tax-deferred, and even if the stock market endures significant lows, you’ll be guaranteed a minimum income.

Additionally,there is no yearly contribution limit for an annuity.  Annuities allow you to sock away a large amount of cash and defer paying taxes. This can be especially beneficial for people who are nearing retirement and have to catch up or people in a high tax bracket now, but who expect to be in a lower tax bracket during retirement.

Should You Get An Annuity?

Because annuities are not funded with post-tax dollars, you shouldn’t consider getting an annuity if you have not taken maximum advantage of the tax-advantaged accounts, like 401ks or IRAs, since the latter two plans tend to have lower fees. 

Understanding the tax implications of holding an annuity relative to other types of retirement investment vehicles is also crucial. Payouts from annuities are taxed at higher rates than other types of retirement accounts, since they are taxed as ordinary income as opposed to long term capital gains.

The current ordinary income tax rate ranges from 10 percent to 39.6 percent depending on income, whereas the long term capital gains tax rate is 0 percent for taxpayers in the 10 percent and 15 percent tax brackets, and 20 percent for taxpayers in the 39.6 percent bracket. This spread can make a huge difference, depending on your income at retirement.

Before You Buy An Annuity

With any contract you sign and any financial product you buy, it is always wise to ask questions and thoroughly understand what you are buying. Yes, there are regulations in place to protect consumers up to a certain basic limit, but no one cares more about your money than you do. So, before you buy an annuity make sure you understand the annuity and have done your research. Moreover, make sure you are buying a product that is suitable for your needs and goals, and are buying it from the best possible source.