Retirement is on the horizon for many Americans. Since traditional pensions are nearly extinct, the question isn’t if you need a reliable and strong retirement income strategy, it’s which strategy works best for your needs. Fixed annuities are a popular and valuable tool in the modern retirement planning toolbox. They help individuals create a steady, predictable income stream.
Since June is National Annuity Awareness Month, it’s the perfect opportunity to highlight what annuities are, how they work, and why now may be the ideal time to explore how an annuity may fit into your retirement plan.
What is an Annuity?
Simply put, an annuity is a contract between you and an insurance company. Initially, you invest a lump sum or series of ongoing contributions, and in return, the insurer provides guaranteed income payments either monthly, quarterly, annually, or as a one-time payment. Furthermore, annuity contract holders can opt to receive payments immediately, for the rest of their lives, or a set number of years.
One of the biggest advantages of an annuity is that the money you invest grows tax deferred. Thus, you won’t pay taxes on earnings until you withdraw them. This gives your savings more time to compound. Additionally, unlike IRAs or 401(k)s, there’s no contribution limit for an annuity.
Types of Annuities Explained
There are two main types of annuities we’ll touch on: fixed annuities and variable annuities.
Fixed annuities (most stable option)
Fixed annuities offer a guaranteed interest rate and payout. This is usually a set dollar amount or a percentage of the assets in the annuity. For this reason, they are commonly used for retirement income security because this type of annuity protects your principal from market volatility.
Variable annuities (market-linked growth)
Variable annuities allow you the opportunity to allocate premiums across investment subaccounts, offering higher potential returns. While there’s a chance for higher returns, the flipside is that these annuities also come with more risk. Variable annuity subaccounts fluctuate with market conditions, so they may be worth more or less than the original amount invested when the annuity expires.
If you’re interested in a strategy that combines two different annuities to help generate income and rebuild principal, read our blog post about the split annuity strategy.
How Do Annuities Work?
Annuities generally work in two phases: accumulation phase and distribution phase. In short, these stages are designed to help you grow savings, and later, turn those savings into retirement income.
- Accumulation Phase – This is the stage in which you contribute money that grows tax-deferred.
- Distribution Phase – Once you’re ready to begin using your savings, the annuity enters the distribution phase. At this stage, the insurance company provides regular income payments or one lump sum based on your contract terms.
Overall, the two-phase annuity structure helps many retirees build a more predictable and reliable income stream during retirement.
A Real-World Example: How a Fixed Annuity Grows
Meet Robert, a 52-year-old business owner who invests $100,000 into a fixed annuity with a 4% guaranteed return.
- Over 15 years, his contract grows tax-deferred to over $180,000
- At retirement, it begins paying him $13,250 annually. Only a portion of each payment is taxed as income (the rest is a return of principal).
- If Robert lives to 85, he’ll receive more than $265,000 in total payments from an initial $100,000 investment.
This example helps demonstrate how annuities can convert savings into lifetime retirement income. As a result, they contribute to greater confidence and peace of mind as you get close to retirement.
7 Reasons Annuities Deserve a Place in Your Retirement Plan
As retirement approaches, protecting what you’ve built throughout your life is just as important as growing it. That’s why more individuals are exploring fixed annuities to help safeguard their savings, generate reliable income for retirement, and prepare for the unexpected.
Whether you’re nearing retirement or already there, here are seven reasons annuities may be worth considering as part of your retirement plan.
1. You’re at, or approaching, 65 years old
The U.S. has been experiencing a retirement wave, dubbed “Peak 65” in the retirement industry. Your needs will likely change in retirement, as you transition from accumulating assets to protecting what you have. For this reason, fixed annuities offer protection from various risks and predictable lifetime income when you need it most.
2. Lock in your market gains
If you’ve done well in the equity markets and want to lock in the gains you’ve generated, a fixed annuity protects your principal, including the gains. In fact, a Fixed Indexed Annuity (FIA) even lets you continue earning interest based on the market’s upside—without the downside risk.
3. Minimize your tax burden with tax-deferred growth
An intrinsic value of annuity products is the tax-deferred build-up of accumulated interest and product gains. With federal and state income tax rates expected to continue rising, annuities can help minimize your tax burden. Therefore, annuities can be a valuable part of your holistic retirement planning strategy.
4. Protect your money from various risks
Fixed annuities are insurance products, not investments. Because of this, they are designed to protect you from a variety of risks. Some of these risks include market risk, inflation risk, deflation risk, sequence of return risk, and long-term care risk. Most importantly, fixed annuities can mitigate longevity risk (the potential to outlive one’s savings), by creating a reliable income stream that lasts for the duration of your life.
5. Help close any income gap in your retirement plan
In 1980, 60 percent of private sector workers relied on income from an employer pension.1 Today, however, pensions have largely disappeared. Many companies are now offering 401(k)s and other retirement plans instead. With the uncertainty of traditional forms of retirement income, annuities help close any income gap you may have in your retirement plan. Essentially, annuities act as a personal pension you fund and control yourself.
6. The annuity fee structure is transparent
Unlike many investment products, fixed annuities are built to address the associated costs of ownership upfront. So, unless you make early withdrawals, terminate your contract, or choose to pay for an optional rider delivering specific benefits, you will not be charged fees.
7. Today’s annuities are extremely flexible
Modern annuities aren’t your grandparents’ insurance products. Innovations in annuities can provide more reliable accumulation, bigger income payouts, and other features like long-term care benefits. When combined with benefits like tax deferral, defined liquidity, and payout guarantees, fixed annuities can address a variety of retirement needs.
Is an Annuity Right for You?
Annuities aren’t one-size-fits-all. But, for those entering or nearing retirement, they offer something increasingly rare: certainty. Fixed annuities provide a guaranteed income stream, tax-deferred growth, and protection from market risks. This proves desirable for many Americans looking to a plan a strategy that will support the life they want to live in retirement.
So, are you ready to explore whether an annuity fits your retirement plan? Reach out to Logix Financial Consultants to schedule a no-cost, no-obligation review of your financial goals.
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The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation.
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Fixed and Variable annuities are suitable for long-term investing, such as retirement investing. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply. Variable annuities are subject to market risk and may lose value.
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