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Guaranteed income for life sounds like a great deal. It’s what many annuities promise, yet nothing is ever as good — or as easy — as it seems.
If you’re considering purchasing an annuity to supplement your retirement income, it’s important to understand the risks, fees and restrictions involved.
Let’s get started.
What Is An Annuity?
An annuity is a contract between you and an insurance company where in exchange for paying them a sum of money, they agree to provide you with a steady income stream.
The purpose of an annuity is to keep you from outliving your retirement assets by acting like a paycheck during retirement. In some ways, they are similar to a pension, providing a set amount of income in exchange for turning over cash.
Annuities are not investments — they’re contracts. And like many contracts, annuities can get complicated.
“People say they’re confusing and they can be. They’re just not easy to understand and not easy for professionals to understand,” said Andrew Barnett, a certified financial planner with GFA Wealth Design based in Fort Myers, Florida.
How Do Annuities Work?
When you purchase an annuity, you either make a single lump sum payment or a series of payments over time to an insurance company.
Disbursements can begin almost immediately or at some designated point in the future. The payouts often last the lifetime of the policy holder.
You choose how frequently you receive future annuity payments, such as monthly, quarterly or yearly.
The funds enjoy tax-deferred growth, so you only pay taxes on the proceeds when you receive payments.
There is no contribution limit, but contributions do not reduce your taxable income the way traditional 401(k) contributions do. There is also a 10% penalty from the Internal Revenue Service (IRS) to withdraw any funds before age 59.5.
How Your Income Is Calculated with an Annuity
The dollar amount of annuity payments depends on the life expectancy of the person…
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