Depending on the type of annuity you are considering, you generally can choose among three ways of paying for it:
Immediate and deferred annuities can be purchased with a single premium payment. Retirees often purchase single-premium immediate annuities with money from an employer-sponsored retirement plan, savings account, the cash value (or death benefit) from a life insurance policy, or the sale of a home.
Deferred annuities have the option of periodic level premium payments of equal premium amounts at regular intervals until the payouts are scheduled to begin, or periodic flexible premium payments over a set period of time, but you have the option to vary the premium amount paid and skip making deposits.
Most annuities have death benefit protection. If you die before payouts begin, your beneficiary will receive at least the amount you contributed, less any withdrawals you’ve taken. With a variable annuity, the death benefit is either the current account value less withdrawals or what you’ve paid in premiums, whichever is greater. These benefits are explained in each annuity contract.
If you die after payouts start, depending on the type of annuity you choose, your beneficiary receives the remaining value of your annuity.
Earnings in an annuity build up free of current federal income tax. When you withdraw money or receive income payouts, the part that comes from earnings is taxed as ordinary income. The part of the payout that represents your premium is not taxed if you bought your annuity with after tax dollars.
There are no annual limits on the amount of money you can contribute to an annuity not in a qualified plan. This gives you additional flexibility compared to other retirement savings plans, such as 401(k)s or IRAs, which place limits on how much you can contribute each year.
Some variable annuities offer guaranteed living benefits for an extra cost. The following options guarantee some benefit to the annuitant, regardless of the performance of the investments you choose:
A guaranteed minimum income benefit guarantees a set minimum lifetime annuity payout even if your account falls below the level needed when your payments begin.
A guaranteed minimum accumulation benefit guarantees that the value of your annuity will be at least equal to the minimum amount, usually equal to your investment or slightly greater, at a future date. If the contract value is less than the guaranteed value, the insurance company will add money to the account.
A guaranteed minimum withdrawal benefit guarantees that you can withdraw a set percentage for your life or the life of you and your spouse.
A guaranteed minimum death benefit locks in the amount you can leave your beneficiaries to prevent the amount from being decreased due to declines in your account value.
There may be additional living benefit options available if you need long-term care (for example, if you enter a nursing facility). Usually there is a waiting period required before you can use this feature.
Variable annuities allow you to select from among a variety of investment options, including different types of investment portfolios that reflect the performance of mutual funds. You also are able to make transfers among these different options (which are generally not limited to single fund families) without being subject to short-term capital gains taxes.
In addition, the allocation of assets among several different asset classes may be useful in helping to produce the long-term returns you are seeking, while managing your exposure to financial market volatility. Of course, asset allocation does not assure a profit or protect against a loss.
Other Product Options
In addition to the various payout options and death benefits, certain types of annuities provide additional protections. Some variable annuities allow you to choose a “stepped-up” death benefit. Under this feature, the guaranteed minimum death benefit may be based on a greater amount than is held in the account. The purpose of this benefit is to lock in your investment performance and prevent a later decline in the value of your annuity from reducing the amount you expect to leave to your heirs. This feature carries an extra charge.
There may be other options available to you when you purchase your annuity. It is important to discuss all options with your financial advisor.