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Retirement Annuities

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What Are Annuities?

Annuity Definition:a contract between an individual and an insurance company promising lifelong income in exchange for an upfront payment.Annuities, at their core, are simple financial instruments: you give me a chunk of your savings and the Insurance Company will send you a monthly payment for the rest of your life, no matter how long you live. In practice, this arrangement gets fleshed out in various ways. The most common scenario is when retirees see that their savings aren't sufficient to last through all of retirement, and make an upfront payment to a life insurance company in exchange for a promise of life-long monthly income. Retirees gain the peace of mind that they won't outlive their savings and left over money upon death can be given directly to their named beneficiaries for their lifetime if so setup.

Annuities Explained by Type

As always, the devil is in the details. What type of annuities exist and how do they actually work? There a several fundamental types of annuities geared to different retirement planning stages. The two most common stages are:

  1. Building up a retirement nestegg during one's working years (Deferred Annuities)
  2. Extending the purchasing power of the nest egg after retirement (Immediate Annuities)

Let's take a closer look at howdeferredandimmediate annuitiescover both cases:

Deferred annuities are used to generate savings. A deferred annuity works very much like a 401(k) or IRA, allowing investors to deposit small sums of money over the course of many years to build up a sizable retirement nestegg which can then be annuitized (turned into a lifelong income stream).

Immediate annuities are used to extend the purchasing power of an existing nestegg. Immediate annuities work like CDs, where a large chunk of one's retirement savings is given to a life insurance company in exchange for a life-long stream of monthly payments. This is the "classic" annuity. The key difference between CDs and immediate annuities, is that the annuity pays a higher interest rate and guarantees a stream of income that cannot be outlived, which is ideal for retirees.

Three Other Types of Annuities

Beyond the funding distinction that separates deferred from immediate annuities, there is also the different ways annuities generate income. When the insurance company receives payment, they invest the money in one of three different ways:

  1. Fixed Annuities:interest earned from debt instruments like CDs, bonds, and mortgages.
  2. Variable Annuities:interest earned from equity instruments like stocks and commodities.
  3. Indexed Annuities:interest earned from broad market indicies like the S&P 500.

Fixed Annuities

An investment in fixed-interest instruments like CDs, bonds, mortgages, and various others debt-investments gives rise to the fixed annuity. A fixed annuity most-resembles a CD in that it guarantees a fixed-interest rate up front. The fixed annuity contract specifies an interest rate that funds will earn for every year they're held by the insurance company. The fixed annuity is perfect for conservative investors because it has virtually no risk of capital loss, short of a total company collapse.

Variable Annuities

Alternatively, an investment can be made in equities-based instruments and commodities, which gives rise to the variable annuity. A variable annuity most-resembles a 401k in that the account balance fluctuates with the ebb and flow of the markets. The insurance company doesn't promise a fixed rate of return, but over the long run, equities tend to out-perform debt-based instruments, making variable annuities appealing to more aggressive investors.

Index Annuities

The final alternative to how annuity income gets generated is called the indexed annuity. An indexed annuity works by investing money in an equities index, like the S&P 500, but with protection against capital loss. Essentially, the insurance company caps earnings during high-growth up markets in exchange for covering investors against any losses during down markets. Indexed annuities fall somewhere in between fixed and variable annuities in terms of its risk profile and average rate of return. The client shares in the gains of the Stock Market but
not the loses. You get the best of both Worlds.

Benefits

  • Lifetime Income Stream
  • Tax-deferred Growth
  • Competitive Fixed Interest Rates
  • Protection Against Market Downturns
  • Death Benefit Options
  • Access to Your Money
  • Absolute Safety