Annuities 101

“Will my savings last after I retire?”

It’s a common question. To answer it with confidence, many investors turn to annuities to provide a reliable income stream in retirement. If you’re considering an annuity for retirement income, this annuities FAQ will answer some common questions and help prepare you for a conversation with your financial advisor.

Not sure whether an annuity is right for your retirement goals? An Ameriprise financial advisor will provide you with personalized advice based on your income needs, as well as solutions to help protect you from uncertainty.

 

What is an annuity?

An annuity is a long-term insurance product that provides guaranteed income.

They are a common source of retirement income because they provide a steady stream of payments at regular intervals and because their earnings grow tax-free until you withdraw funds. All annuities also offer a death benefit that protects your original investment for your beneficiaries.1

With people living longer and thus experiencing more market cycles throughout their lifetimes, annuities can to help fill the gap between other sources of guaranteed and stable retirement income — such as pensions or Social Security — to cover essential expenses if needed.

How do annuities work?

With an annuity, you pay the annuity company premiums for a period of time, and then the annuity company starts paying you. 

In general, there are two stages in the life of an annuity:

  1. In the accumulation phase, you pay premiums into the annuity. You can do this either with a lump sum or over a specific period of time, depending on the type of annuity.
  2. During the distribution phase, you’ll receive monthly, quarterly or annual payments according to the terms of the annuity contract.

What are the different types of annuities?

There are two categories of annuities — deferred and immediate — and several types of annuities within each category. The most common deferred annuities are fixed annuities and variable annuities. Each offer a range of options to meet your needs.

Deferred annuities

  • Fixed annuities: Offer a fixed rate of return guaranteed to never fall below a minimum rate. They also offer the option to annuitize — or convert your account to a series of guaranteed income payments — for either a specific period of time or for as long as you live during retirement. 
  • Variable annuities: Offer growth potential from the underlying funds you choose. In addition, they provide a guaranteed death benefit for your beneficiaries. They also offer the option to annuitize.
  • Structured annuities provide opportunities for growth and a level of protection that can help eliminate some of the risk that comes with investing.
  • Fixed index annuities credit interest based on the performance of indexes using a cap or spread.

Immediate annuities 

  • Immediate annuities guarantee an income stream in return for a lump-sum payment. You can choose from a variety of income options, including some that provide income for your spouse or beneficiaries if you die prematurely.

All guarantees are based on the continued claims-paying ability of the issuing company and do not apply to the performance of the variable subaccounts, which will vary with market conditions.

Other annuity factors to consider

An Ameriprise financial advisor can help you evaluate the different types of annuities and take your financial situation under consideration to determine which type of annuity is right for you. Your advisor will ask questions about:

  1. Timing of your first payout
  2. Your risk tolerance
  3. Payout period

Timing of first payout: Immediate vs deferred annuities

When would you like the distribution phase to begin? Do you want payments to start immediately or be deferred to the future?

  • Immediate: With an immediate annuity, you pay the principal (usually in a lump sum) and begin receiving payouts right away. This is a popular option for those about to retire.
  • Deferred: With a deferred annuity, you make contributions ahead of time and receive the first payment on the date specified in your contract. Because your money has more time to accrue interest tax-free, your payout amounts can be higher than those of an immediate annuity.

Risk tolerance: Fixed vs. variable annuities

Different annuities carry different amounts of risk. Do you feel more comfortable with a fixed interest rate on your principal investment or are you willing to accept more risk for a variable — possibly higher or lower — rate of return?

What’s your risk tolerance? Take our risk tolerance quiz

  • fixed annuity offers a specified rate of return, like a Certificate of Deposit (CD). You haven’t invested your principal in the markets, so your returns will not fluctuate with the markets.
  • variable annuity offers the potential for greater income than a fixed annuity because it’s invested in the markets. However, with the potential for greater returns comes greater risk.

Annuity payout options

Do you want an annuity that guarantees payments for the rest of your life, one that pays out for a predetermined amount of time, such as 5 or 30 years, or some combination?

  • With a life payout, you will continue to receive payments until you pass away. Payments will not continue for your beneficiary.
  • With a period certain payout, you will receive payments for the period of time your contract specifies. If you pass away before the end of the period, your beneficiary will receive the payments until the end of the period.
  • joint-life payout provides a lifetime payout for the investor and one other person, typically a spouse.
  • life with period certain payout provides payments for the rest of your life, but if you pass away during a specified period, your beneficiary will receive payments for the rest of that period.

Are annuities taxable?

  • Annuities are tax-deferred, which means you won’t have to pay income taxes as the money grows.
  • They’re intended for retirement investing, so withdrawals made from an annuity before age 59½ may be subject to a 10% IRS tax penalty.
  • After age 59 ½, you will generally have to pay taxes on the money you withdraw.

Learn more about annuities and taxes.

Annuity vs. IRA

Because annuities are tax-deferred and typically used for retirement income, it’s important to consider the differences between an annuity and other similar tax-deferred methods of saving for retirement, such as a 401(k) or an IRA.

Considerations:

  • Annuities do not have annual contribution limits like 401(k) IRA plans.
  • Annuities tend to have higher fees than 401(k)s and IRAs.
  • Annuities can provide stable, guaranteed income regardless of how financial markets perform.

Are annuities only for retirees?

Annuities can be part of your financial picture in your working years as well as during retirement.

Because deferred annuities offer tax-deferral1, you have more time to grow your money without paying income taxes on earnings. In that scenario, if you choose a variable annuity, you may have the option to invest in the stock market for growth and to protect your principal for beneficiaries.

Two additional reasons you might purchase an annuity before retirement: 1) to roll over a workplace retirement account when you change jobs; and 2) to continue saving after you reach 401(k) or IRA annual contribution limits.

Is an annuity right for you?

When is the right time to stop working and retire? Will your money last as long as you need it to? How can you protect your retirement income from losses?

These are key questions to discuss with an Ameriprise advisor, who will provide you with personalized advice to help you achieve your financial goals.

 

1Most annuities have a tax-deferred feature. So do many retirement plans under the Internal Revenue Code.
As a result, when you use an annuity to fund a retirement plan that is tax-deferred, your annuity will not provide any necessary or additional deferral for that retirement plan. But annuities do have features other than tax deferral that may help you reach your retirement goals. Consult your tax professional prior to making a purchase for an explanation of the tax implications.
This information is being provided only as a general source of information and is not a solicitation to buy or sell the securities mentioned. The information is not intended to be used as the sole basis for investment decisions, nor should it be construed as advice designed to meet the particular needs of an individual investor.
Variable annuities are insurance products that are complex long-term investment vehicles and are subject to market risk, including the potential loss of principal invested. Before you invest, be sure to ask your financial professional about the variable annuity's features, benefits, risks and fees, and whether the variable annuity is appropriate for you, based on your financial situation and objectives. 
Withdrawals that do not qualify for a waiver may be subject to a withdrawal charge. Withdrawals are subject to income taxes and withdrawals before age 59-1/2 may incur an IRS 10% early withdrawal penalty.
Contracts and features may not be available in all states or may vary by state.
There is no guarantee that the annuity will keep up with inflation.
Most annuities have a tax-deferred feature. So do many retirement plans under the Internal Revenue code. As a result, when you use an annuity to fund a retirement plan that is tax-deferred, your annuity will not provide any necessary or additional deferral for that retirement plan. But annuities do have features other than tax deferral that may help you reach your retirement goals. You should consult your tax adviser prior to making a purchase for an explanation of the tax implications to you.
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