Deferred Annuities: A Way to Save Money for Retirement
Many people buy annuities because they want their money to grow tax deferred while they are saving for retirement, and they want a guaranteed income stream once they retire. This type of annuity is called a deferred annuity. A deferred annuity contract has two phases—an accumulation or savings phase, and a payout or retirement income phase.
In the accumulation phase, the owner pays premiums (also referred to as purchase payments) into the contract to accumulate assets. Some contracts are purchased with a single payment and thus are called single premium contracts. Other contracts allow payments to be made at any time and thus are called flexible premium contracts. During the accumulation phase, the owner can surrender the contract or take one or more partial withdrawals.
In the payout phase, the owner (or other designated payee) receives income. When he or she wants payments to begin, the insurance company starts sending checks on a regular basis, typically monthly. The effective date of payments is called the annuity start date or the annuity commencement date. In certain circumstances, the insurance company will allow annuity payments to be commuted for a lump sum equal to their present value.
Immediate Annuities: When You Want to Receive Money Right Away
An immediate annuity (also called a payout or income annuity) is purchased with a single premium and annuity payments begin right away (there is no accumulation period). If the owner chooses to receive monthly payments, they usually start at the end of the first month, but may be scheduled to start any time within one year after purchase. An immediate annuity can be purchased using retirement savings, for example, from a 401(k) plan and/or personal savings, as a way to create guaranteed income payments during retirement. It can also be purchased using money from other sources, such as an inheritance or the sale of a business.
Annuity payments can be made over the lives of one or more individuals or for a specified number of years, e.g., for 10 or 15 years. Life annuity payments typically end when the annuitant dies, but various types of guarantees are widely available. For example, you can purchase a life annuity with 10 years of payments guaranteed. Under such an annuity, the payments will continue for the longer of 10 years or the annuitant’s life. In addition, insurers offer annuity payments that provide that if the annuitant dies before annuity payments equal to the premiums paid for the contract have been paid, the contract beneficiary will receive a lump sum equal to the difference between the sum of the annuity payments and the premiums paid. As there are a number of payout options offered by companies, the owner should work with his or her financial advisor to ensure that the payment feature meets his or her particular financial condition and needs.
An inflation-protected annuity (IPA) is similar to an immediate annuity but payments are indexed to the rate of inflation. Initial payments will usually be smaller than they would be without the inflation protection. Even at a moderate rate of 4 percent, inflation reduces the purchasing power of one dollar to fifty cents in approximately 15 years. IPAs guarantee a real rate of return at or above inflation. Very few life insurance companies offer true IPAs for sale in the United States (largely due to the difficulty of hedging the inflation risk). However, consumers can buy immediate annuity contracts that provide pre-determined annual increases in the amount of annuity payments, e.g., 3 percent each year for the life of the contract.
Structured Settlement Annuities
Structured settlement annuities are used to provide ongoing payments to an injured party in a lawsuit.
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