What You Should Know About Annuities

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Everyone. And thanks for joining me this week. My name is Laura Adams and I’m a personal finance and small business expert and author. Who’s been hosting the money girl podcast since 2008. My mission is to help you the knowledge and motivation to prioritize your finances, build wealth and have more security and less stress.

Every show is created to make sure you come away with practical advice that will help you make better money decisions and ultimately take your financial life to the next level. Be sure to subscribe to the show and participate by sending me your money questions or your comments. You can do that 24 7 on our voicemail at 3 0 2 3 6 4 0 3 0 8. And you can email me using my [email protected] or connect with me on Instagram at Laura D. Adams. If you want to read a companion blog post for this or any money girl podcasts, they are always published in the money girl [email protected] Today’s episode is number 695 called what you should know about annuities. This show was inspired by a question I received from Marsha. You Marsha says I work at a university, so my retirement is through T I a.

When I recently spoke to their rep, she suggested an annuity with half as a variable product. I’m 65 years old and will retire at age 70. So I have some time to decide. Can you do a podcast to explain what I should know about annuities, Marsha, thank you so much for your question. Annuities can be a wise way to save for retirement if you fully understand them. So I’m delighted that you asked. It’s actually been awhile since I have a podcast about annuities. This show will review how annuities work, the different types and how they relate to saving enough for a comfortable retirement. So let’s start with just a general primer on what is an annuity. These are products that have been around a long time, and they’re commonly used by conservative retirees who want to make sure that they will have a regular income for the rest of their lives.

This is becoming more and more important because fewer of us are, are getting a big fat pension from our employer. And it’s really becoming a luxury that few American workers can look forward to in retirement. So in a new city may compliment other retirement plans that you have like a 401k at work or a IRA or a SEP IRA that you’ve got on your own, uh, as an individual or a self-employed person in its very simplest form. An annuity is a contract between you and an insurance company that will provide a combination of insurance and investment features. They’re complex products. So, uh, you know, I say in its simplest form, that’s what it is. But in reality, there are many different types of annuities. They have many different options that you can choose that for different price points. There’s just a lot to know and select from when you go to buy an annuity.

And that’s why they really are something that you need a lot of advice in order to purchase, uh, successfully, I would say, and they’re sold by various institutions and professionals, such as insurance companies, banks, brokerages, and financial advisors, the investment firm that manages Marcia’s retirement that she mentioned T I a is one of the largest pension funds in the United States. They manage retirement accounts for workers and many fields like universities, government jobs non-profits and even medical services. So I like that. Marsha is speaking to her rep about what these products are and getting some advice there. But let’s say you don’t have an annuity as part of your retirement plan at work to purchase an annuity. You make either one or multiple payments in exchange for a set amount of income over a period of time. So depending on what type of annuity you select, it might give you things like guaranteed income for your entire life tax deferred growth, a guaranteed return on your investment protection from investment losses, flexible withdrawals, and some protection for your beneficiaries.

So that’s a lot of great stuff that they can provide, but we also have to think about the downsides of annuities, and I’m going to talk about those. So you want to think about an annuity as a long-term investment. It’s designed for retirement, and they’re going to help replace a paycheck with predictable income. And that income can either be paid for a period of time or for your entire life. And it is backed by the claims paying ability of the issuing insurance company. So in other words, an annuity is really only as good as the company that is selling it to you. And for many people, buying an annuity gives a lot of assurance that they’re not going to outlive their investments in retirement. One key advantage of an annuity is that you can contribute as much as you want for retirement provided you have a non-qualified annuity, and I’m going to get more into that in just a moment.

Unlike other tax deferred retirement accounts, like a workplace 401k or an IRA, which have annual contribution limits annuities do not have any annual contribution limits. And that’s, if you’re buying them outside of a retirement account, and we’ll talk about that in a moment. So having no annual limit can be really helpful. Let’s say you’re getting close to retirement and you really need to catch up. And you’re looking for a tax advantage account. An annuity might be the way to go. So let’s talk about how they work. As I mentioned, you can purchase an annuity by making a lump sum. So like, if you get a really big amount of money, you can buy an annuity with that lump sum of money, or you can purchase an annuity with multiple smaller payments over time. Those are called premiums in return. The annuity provider invests your money for you.

And they typically give you a series of payments, which is known as a new organization. So turning a sum of money into a series of payments over time is a new integration. So let’s talk about the three main types of annuities. The first is called a fixed annuity. It’s called fixed because it pays out a fixed rate of return on your money. And this could be for life, or it could be for a period. Maybe you just want that return for 10 years, 15 years, or for life. It is a guaranteed predictable income stream, no matter what’s going on in the financial markets. So that’s why it’s called fixed. You’re going to get that fixed amount of money, no matter what’s happening with the stock market. So that’s the first type. The second type is called a variable annuity and it’s variable because it pays out a variable rate of return on your money.

So the income stream that you get usually has a minimum guaranteed amount, but it can increase depending on the performance of the underlying investments that you select. So I’m talking about investments like mutual funds. Uh, so again, this is going to provide a minimum amount of, of income, but it’s variable because it could be higher. The third main type of annuity is called an indexed annuity. This pays a return on your money. That’s tied to an index that could be the S and P 500. It’s considered a hybrid of the first two types that I just talked about because you will receive a minimum guaranteed payment over a period of time or for life. However, you can also get a higher return on your money when there are gains in the broader market. So as you can see, there’s a variety of ways that your money gets invested with an annuity.

So that’s key is really understanding what you’re buying. Marsha said that her T I, a representative recommended a half variable annuity. I’m not sure exactly what the rep is referring to, but it may be an indexed product. And she may be recommending this because with variable and indexed annuities, you’ve got, got more risk, but you also have the opportunity for higher returns on your investment, depending on the performance of the financial markets. Now, in addition to annuities, having different investment options, like I just mentioned the fixed, the variable and the index. There are two main ways that an annuity Compay you, depending on whether it is called immediate or deferred, an immediate annuity provides income right away, or at least a year after you buy it, you make a lump sum payment called a single premium. And then you start receiving a monthly income stream.

Let’s say your partner or your spouse passes away and you receive a life insurance benefit, a life insurance payment of $1 million after taxes. And you want to simplify your life and create a monthly income stream. By putting that million dollars into an annuity, you can use various immediate annuity calculators to see what the payout would be based on your age and your gender. Let’s say you’re a 40 year old female, a $1 million annuity will give you a little more than $3,000 a month for the rest of your life. The payout does change depending on when you buy an annuity. If you let’s say you waited a new purchase, the same million dollar annuity at age 60, instead of at age 40, it would pay out a bit more would pay on about $4,000 per month. And that’s because as you get older, your life expectancy is lower.

And so this is all based on a life and life expectancy, as well as the amount of money that you put into the annuity. Okay. Besides an immediate annuity, the other broad category is deferred annuity. This is where you receive income at a future date. So you’re going to make one or multiple contributions during the annuities savings phase. And then you receive income either as periodic payments, or even as a lump sum payout during what’s called the distribution phase. The payout doesn’t begin for at least a year after your last premium payment, but you could defer it by 40 years. If you wanted to a deferred annuity is very similar to how a retirement account works, where you set aside money over time that you’re going to access in the future. In fact, you can own a deferred annuity inside of a retirement account, such as a traditional IRA, a 401k, or a 4 0 3 B. This is probably the situation with Marsha’s Tia account.

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Get help writing your emails, reports, presentations, resumes, and blogs today go to w O R D T U N e.com/money girl. So if you own an annuity inside of a retirement account, it’s called a qualified annuity. And that’s because it is going to be subject to all those retirement account rules that you hear me talk about on the podcast. For instance, your contribution limits are tax deductible up to an annual IRS limit, and you defer paying tax on the annuities earnings each year until you decide to take withdrawals after age 59 and a half. But just like with a regular retirement account, you must begin taking distributions with a qualified annuity. Once you reach age 72, that’s following traditional retirement account rules. So owning an annuity inside of a retirement account means that you do have to follow all of those regular retirement account rules, but if you own it outside of a retirement account, that’s called a non-qualified annuity.

And with that type, you only have the option to contribute after tax dollars. And as I mentioned, there are no annual contribution limits. So you can put in as much money as you like. And even though you do have to pay tax upfront on the contributions you make to a non-qualified annuity, you do defer paying on investment gains until you take withdrawals after age 59 and a half. So that’s a really nice tax benefit. And unlike a qualified annuity, you don’t have to start taking distributions at any specific age. So you don’t get as many tax advantages with a non-qualified annuity. However, it doesn’t come with as many restrictions either. Now when it comes to annuities and really any type of insurance, you’re going to hear the term rider, R I D E R a lot. And this is kind of like you add a rider to a home insurance policy to protect valuable jewelry.

You can add a rider to an annuity to receive optional, additional benefits above the standard contract. Here are a few common annuity riders. One is an income rider. This one provides guaranteed income for a certain period that you can turn on in the future. And so that’s very popular for retirees who want to make sure that they don’t run out of money during their lifetime. You might have a death benefit rider. This one ensures that if you die, your beneficiary will receive the balance of your annuity, not the insurance company. So for example, if you purchase an annuity for a hundred thousand dollars, but you die after receiving $20,000 of distributions with this rider, your beneficiary would receive the $80,000 balance. Another option is a nursing home rider. This helps pay for expensive longterm care, either at home or in a nursing facility. For instance, it could double your monthly income or even allow you to withdraw more of your annuity balance to cover your added costs.

If you need nursing home care, terminal illness rider, this one allows you to access some or all of your annuity balance without having to pay any early withdrawal fees or surrender penalties. If you’re diagnosed with a terminal illness that reduces your life expectancy. So adding a rider to an annuity gives you some extra financial protection, but it comes with an extra cost because it typically increases the amount of income that you receive. A common question that comes up with annuities as well. You know, Laura, if I put this money in an annuity, what happens if I need the money later on for something like medical bills, as I mentioned, a deferred annuity acts a bit like a retirement account, even if you don’t own it inside of a retirement account, because you enjoy tax deferred growth until you take withdrawals after age 59, but you do need to wait until age 59.

If you want to enjoy the full benefit of your annuity. If you take an early withdrawal before 59 and a half, you’re going to typically be subject to income tax on that withdrawal. Plus a 10% penalty. Some annuity providers also charge an additional penalty, which is called a surrender charge for taking an early withdrawal from an annuity. So I really would recommend that you don’t purchase an annuity with money that you think you might need to spend right away. You know, you want to be able to have a financial situation where you’re going to be able to wait and take the full benefit of the annuity and not have to pay taxes or that early withdrawal penalty on an early withdrawal. So again, let me recap with annuities, some of the benefits it’s going to generate guaranteed income and retirement, it gives you the potential to have tax deferred earnings.

So all of the growth earnings in your account does accumulate tax deferred. It’s going to reduce the volatility in your retirement portfolio. Although variable annuities, as I mentioned are subject to market risk. That’s a type of annuity. Um, you know, that does have the most market risk, and it allows you to invest for retirement beyond a 401k and an IRA. But what are the downsides? This is really important to understand what the annuities, so the main advantage to having an annuity is getting payment amounts that are either partially or fully guaranteed by an insurance company. And that’s something that most regular investments such as mutual funds cannot provide. There is always risk of volatility. They do not guarantee a return with an annuity. You do have a guaranteed return, at least a minimum guaranteed return. However, regular investments such as stocks and stock funds offer a long-term upside that annuities generally cannot match.

So in other words, buying an annuity means that you’re definitely protected from the market going down, but you give up the opportunity to earn higher returns. So this is why I say that they’re typically for conservative retirees plus annuities generally come with higher fees than regular investments. So if you take away anything from this podcast, I want you to remember that the value of an annuity is that it reduces your investment risk. It gives you a guaranteed income, but not necessarily the highest potential income for your money in exchange for an annuities fixed or guaranteed payout. It limits your possibility of growth or getting higher income when the market goes up. But in some cases you may be willing to take that you may be willing to transfer the risk of investing to an insurance company. And that may give you peace of mind that your income and retirement would never dip below a threshold.

But again, the downside is that if you put money in regular investments, instead of an annuity, it’s possible that your income could be higher in retirement. Only you can decide whether having a potentially lower amount of guaranteed income is the best choice for you. So there’s a lot to consider when it comes to annuities like taxes and estate planning. In addition, you’ve got all those riders that we covered and probably many more options that you can choose at an additional cost, such as a cost of living adjustment to increase your income each year, according to the inflation rate. So Marcia, you are doing the right thing by speaking with a professional about your options. I’d make sure that you fully understand the pros and cons of different annuities and different writers until you’re confident that it meets you and your family’s needs. Since annuities are a complex financial product, always consult with a qualified financial advisor about whether buying one is a good fit for your longterm financial and retirement planning strategy.

So I hope this has shed some light on annuities, Marsha again, thank you for your question. If you have not joined my free private Facebook group called dominate your dollars, please do it is an amazing group of people who are asking great questions, helping other members and reaching their financial goals. If you want to get into the group, just search on Facebook, or you can text dollars. The word D O L L a R S to the number 3, 3, 4, 4 4. And I’ll send you a direct invitation. That’s all for now. I’ll talk to you next week until then here’s to living a richer life. Money girl is produced by the audio wizard, Steve or Ricky Berg with editorial support from Biatta Centura. If you’ve been enjoying the podcast, I want to ask a very quick favor. That would really mean a lot to me go to your podcast app,

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