Annuity Basics: Understanding how Annuities Work for You


An annuity may seem like something only the very wealthy venture into. It may seem too complex to be a part of your family financial plan.

In reality an annuity can be a great savings option for anyone who would like to make the most of their long term savings that on their own don’t add up to enough to last them a lifetime.

What is an Annuity?
Annuities can be compared to an insurance policy. In many ways they are similar. With an insurance policy for example, you would pay a monthly premium and should there be an accident or damage to the insured property, you are guaranteed to get enough money from the insurer to replace the property.

If it is life insurance, you would get a predetermined amount of money given to your beneficiary that would be dependent upon how much you paid in your monthly premium. With an annuity, you would make periodic payments to either a financial institution or an insurance company. The amount you pay each period and for how many years, would determine how much of an annuity payment you would receive.

Annuity Example
For example, you could purchase an annuity that is guaranteed to pay you $1000 per month for the rest of your life. You would make monthly payments determined by the insurer, usually for a term of 20-25 years. Over the course of the years, you may have paid $30,000 into the annuity, but as long as you live for more than 30 months after you stop making payments and start receiving the payout, you have gained a significant amount on your investment. If you were not to outlive the 30 months, any balance in your account would belong to the insurer.

Many life insurance policies are called “whole life” as opposed to “term life” policies that pay one flat amount to the beneficiary of the insured. With a whole life policy you are essentially buying into an annuity.

Annuities and Retirement
Retired people who have saved during their working years and put money into their company’s 401k plan, can also use those funds to purchase an annuity one time with the funds and further defer some of the taxes. When money from a 401k is withdrawn upon retirement it is taxed as regular income in that year. By using the 401k money to purchase an annuity, taxes will only be due on the portion received from the monthly annuity payment and not the full amount in the 401k all at once.

Annuity Benefits
The biggest benefit from buying an annuity from a 401k is if you believe you will outlive your savings. If you have only saved $50,000 and retire at age 62, then that money, along with any other savings and Social Security payments, will have to probably last you anywhere from 10-25 years. With an annuity, you would turn over the $50,000 for a guaranteed monthly income for the rest of your life.

Buying an Annuity
Choosing an insurer or other financial institution to purchase and handle your annuity is similar to shopping around for the best bank account with the highest interest rates or finding an insurance policy with the best premiums. There are many, many options from which to choose. The specifics will be spelled out by the insurer and there should be no surprises. The best part might just be knowing exactly what you can count on for a retirement income.

 

Information is for educational  purposes only and is not be interpreted as financial advice. This does not represent a recommendation to buy, sell, or hold any security. Consult your financial advisor.

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