If you've maxed out your contributions to your Individual Retirement Account (IRA) and employer-sponsored plans, then an annuity may be a good investment option to help round out your portfolio.
An annuity is an insurance contract designed to provide retirement income. You, as the annuitant, pay the annuity issuer, who in turns pays out the principal and earnings back to you. The term annuity refers to a stream of payments guaranteed for some period of time—for the life of the annuitant, until the annuitant reaches a certain age or for a specific number of years.
There are two phases of an annuity:
- Accumulation: When money is added to the annuity, either as one lump sum (a single premium annuity) or as periodic payments to the insurance company.
- Distribution: When you begin receiving distributions from the annuity either as lump sums or as a guaranteed income stream for your lifetime or a set period of time.
When choosing an annuity, the first thing you need to do is determine the timing of payout that is best for you. There are two options:
- Immediate Annuities: Distributions begin immediately upon investing. With an immediate annuity, you can choose to receive payments for a certain period of time or for the rest of your life. You can also choose between a fixed payment and a variable payment based on market performance. Immediate annuities are best suited for someone near retirement age who perhaps hasn’t saved enough and needs a steady supplement to Social Security and other investments.
- Deferred Annuities: With a deferred annuity, you deposit your money with an insurance company and let it grow tax deferred until the date set in your contract. A deferred annuity also allows you to choose between fixed or variable payouts. Deferred annuities are best suited for someone under age 40, as investments in these securities usually require 15 or 20 years to reach a return rate above other low-risk investments.
The next decision is to choose the investment type that works for you:
- Fixed: Fixed annuities offer a guaranteed rate of return. The insurance company invests your premium in its general account. Whatever payout option you select, the interest gains and payment amounts are guaranteed by the insurance company, which assumes the risk of investing the general account.
- Variable: With a variable annuity, you choose the investment, and your payout will depend on the performance of the underlying securities in the separate accounts in which your premium is invested. Unlike fixed annuities, the value of your account is not guaranteed—you assume the risk involved in investing your premiums in exchange for potentially higher returns.
- Indexed: The insurance credits you with a return that is based on changes to an index, such as the S&P 500.
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