Life Events

An annuity is a contract with an insurance company. You pay money, either all at once or over time, and the insurer promises to pay you back, either right away or in the future, usually as a stream of income. Annuities are useful for some people and a poor fit for others, so it pays to understand the trade-offs.

The basic types

• Immediate annuity: you pay a lump sum and begin receiving payments almost right away, for a set period or for life.
• Deferred annuity: money grows for years before payments start.
• Fixed annuity: earns an interest rate set by the insurer.
• Variable annuity: your balance is invested in sub-accounts and rises or falls with the market.
• Indexed annuity: credits interest based partly on a market index, subject to caps and other limits.

How they are taxed

Earnings in a deferred annuity grow tax-deferred. When you take money out, earnings are generally taxed as ordinary income, and withdrawals before age 59 and a half may be subject to an additional tax. If you buy an annuity with after-tax money, part of each payment is treated as a return of your own cost and is not taxed, using an exclusion ratio. Annuities held inside an IRA or 401(k) have no additional tax benefit, because those accounts are already tax-deferred.

When an annuity might make sense

• You want a guaranteed income stream for life to cover basic expenses, in addition to Social Security.
• You are concerned about outliving your savings.
• You have already maximized other tax-advantaged accounts.

Drawbacks to watch for

• Fees: variable annuities in particular may include insurance charges, investment fees and charges for optional riders.
• Surrender charges: leaving early may cost a significant percentage of your balance.
• Limited liquidity: money can be tied up for years.
• Complexity: terms and caps can be hard to compare.
• Insurer risk: guarantees depend on the financial strength of the company.

Questions to ask before buying

• What are all the fees, and what is the surrender schedule?
• What happens to payments if I die early? Are there beneficiary or survivor options?
• What is the insurer's financial strength?
• Is the commission affecting the recommendation?
• What are the alternatives, such as bond ladders or other income strategies?

The investor education resources at investor.gov offer additional guidance on variable annuities.

We have no products to sell, so we can give an independent view of how an annuity would fit your taxes and retirement income. Contact us to talk it through.