Annuities 101 - Annuity for Beginners

• By providing a steady source of income you can’t outlive, annuities reduce the risk that you run out of money in retirement.

Annuity Basics

An annuity can provide lifetime income guarantee from an insurance company as a way to reduce the risk that you run out of money in retirement. Just like you insure your home, you can insure your longevity by passing on the risk that you outlive your savings to an insurance company.

There are many ways to fund an annuity — years before retirement, at retirement, over time, etc. — but they all provide you with the same thing: a guaranteed, steady lifetime-income stream that can simplify your retirement spending and offers peace of mind that you will not outlive your savings.

The article below is an overview of the types of annuities on the market today.

Are Annuities Right For You?

An annuity may be right for you if:

• Your Social Security and/or pension benefits are not enough to cover your regular expenses,
• You have already started saving for retirement,
• You are in above-average health and hope to live a long life, or
• You are seeking greater certainty in retirement.

Annuities, are not, however, designed to be the totality of your retirement nest egg, as they don’t provide everything you need in retirement. In particular, they do not have the potential to provide high stock market returns, and they are typically not indexed for inflation.

Immediate Annuities

The immediate annuity, a.k.a. single premium immediate annuity or SPIA for short, is the simplest annuity product on the market. It’s purchased by people retiring within the next year or already in retirement. For a given amount of money paid upfront today, you receive an income stream starting within one year that lasts as long as you live. It is common for the annuity to cover both you and your spouse’s lives, where the income payments will continue as long as either spouse is alive, albeit at lower income stream.

Longevity Annuities

Similar to the simple annuity, longevity annuities, a.k.a. deferred income annuities or DIAs for short, provide lifetime income in exchange for payments made 2-40 years in advance. In the longevity annuity, however, you simply delay receiving these payments for a period of 2-40 years. Because of the deferral, you will receive a higher income stream and are able to include additional payouts to the contract, longevity annuities can be good for people who want income starting years in the future.

Within the longevity annuity category, there is a special type known as a Qualified Longevity Annuity Contract or QLAC for short. The QLAC is a way to purchase a longevity annuity using your qualified retirement savings (such as from an IRA or 401(k) rollover) but delays the start of that income to after age 72. It’s given this special designation because it overrides the IRS required minimum distribution (RMD) rules.

Fixed Rate Annuities

A fixed rate annuity, a.k.a. a multi-year guaranteed annuity or MYGA for short, is more suited to retirement savings, offering: higher crediting rates over longer time horizons, tax-deferred growth, the ability to annuitize upon maturity, and liquidity via penalty-free partial withdrawals. With a fixed rate annuity, you can invest your savings over a specified time horizon (typically 3 to 10 years), earning a fixed return. The interest earned in your fixed rate annuity is not taxed until withdrawn, and your principal is guaranteed.

Annuities 101: Summary

At its core, an annuity is a valuable retirement tool that helps reduce the risk that you or a loved one run out of money in retirement. Because of this protection, annuities are first and foremost an insurance product. This article serves as a good first step by providing a high-level overview of annuities.