Would you like your investments to have a guaranteed return with no risk to capital? Would you like your retirement savings to grow tax-free? Would you like to save more than allowed by your IRA and 401(k)? Would you like to receive guaranteed income for life? If you answered yes to any of these questions, an annuity might be right for you.

How does an Annuity Work?

Americans pour money into annuities at a rate of $140 billion per year. There are more than a quarter of a trillion dollars sitting in annuity accounts. So what’s behind this massive influx of cash?

Annuities insulate investors from economic downturns and market crashes. Remember the stock market during the housing crisis of 2008? How about when Covid hit in 2020? Many people experienced severe losses in those crashes. Having some or all of your retirement savings in an annuity can provide shelter from the storm.

An annuity is a guarantee that you will receive a specific amount of money at a set frequency no matter what the stock market is doing. In short, annuities provide certainty in an uncertain world.

Annuity Benefits

Did you know that people who pay their bills by withdrawing money from their investment accounts experience higher levels of anxiety and stress than those who do not? One of the biggest issues facing retirees is the fear of running out of money. With an annuity, you know you have a predicable source of income for life.

Although the tax-advantaged status is one of the best attributes of an annuity, there are other advantages. Annuities do not have to go through probate. When an annuity owner dies, the balance passes to the beneficiary without going through probate. Annuities are also exempt from creditors.

Types of Annuities

There are three main types of annuities:

• Fixed Annuities pay a guaranteed return similar to a CD or a bond.
• Indexed Annuities promise some portion of growth from the stock market while shielding your principal from loss.
• Variable Annuities contain mutual funds invested in stocks, bonds, real estate, and commodities such as precious metals and energy. Unlike the other two types of annuities, principal is at risk in a variable annuity.

Annuities can be further categorized as follows:

• Immediate Annuities pay out from the start.
• Deferred Annuities pay out at a later date such as when you retire.

Funding Annuities

An up-front investment is needed to initiate an annuity. After that, the annuity is funded by ongoing premium payments.

A single premium annuity is funded by one large payment. Single premium annuities are often the result of a rollover. Annuities can be purchased either inside or outside a qualified plan such as an IRA or 401(k).

Annuity Distributions

There are several options for annuity distributions:

• Straight Life: The annuity will pay out for the rest of your life even if the total payout exceeds the amount paid into the annuity plus accumulated growth. Payments cease upon the annuity owner’s death, even if the total payout is less than the amount paid in plus accumulated growth.
• Life with Period Certain: The annuity will pay out for life but not less than a specified number of years, typically 20. The Life with Period Certain option is designed to prevent the Straight Life scenario from playing out where an annuity owner dies before the amount invested has been fully distributed.
• Joint Life: Same as Straight Life but with two owners, typically a married couple. The Joint Life option continues to pay out as long as one of the owners is living.
• Joint Life with Period Certain: Same as Life with Period Certain but with two owners. The Joint Life with Period Certain option continues to pay out as long as one of the owners is living, and not less than a specified number of years.

Annuities and Taxes

As mentioned, annuities enjoy tax-advantaged status. If the annuity was funded with pre-tax dollars such as a rollover from a qualified plan, all of the distributions will be taxable. If the annuity was funded with after-tax dollars, only the investment returns will be taxable. The taxable portion of annuity distributions are taxed as ordinary income.

The History of Annuities

Annuities have existed in one form or another since the Roman Empire. People paid a lump sum to the Roman government in return for annual payments for the rest of their lives.

Annuities first came to America in the 18th century as a means to support church ministries. Fixed annuities grew in popularity and became a mainstay of conservative investors. Although the first variable annuity was created in 1952, they did not become popular until the 80s. Those were followed by indexed annuities in the 90s.

Final word

Conservative investors are drawn to fixed annuities, while younger and less risk-adverse investors will appreciate the growth potential of variable annuities.

Annuities provide a steady source of income when your working years are over. They offer many benefits and provide secure retirement savings for millions of Americans.

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