Retirement Planning 101: How Does an Annuity Work?

Retirement plan

Depending on your circumstances, your 401k and Social Security might not cut it come retirement time. If you’re currently planning for your retirement, perhaps you should also consider annuities. Annuities are long-term investments that could help supplement your retirement income. You can buy annuities from a reputable insurance agent or company with ample experience in selling annuities, which will distribute your annuity payments.

Variable vs. Fixed Annuities

When deciding o buy an annuity, you could select from to main types, variable and fixed annuities. With a fixed annuity, you receive payouts in equal amounts, while you receive payouts in different amounts based on investment performance with a variable annuity. When you avail of a fixed annuity, you’ll be given an interest rate that will be the basis for your payouts. Although this might be considered a safer bet than a variable annuity, there’s a chance that the inflation rate might outpace your return rate, which essentially reduces your buying power.

With a variable annuity, your payment would be based on your investments’ performance. This means that your future payments would be directly tied to the performance of the investments (bonds or stocks) you chose when you initially invested in a variable annuity. Yes this might be riskier than investing in a fixed annuity since the performance of your investments could go either way, but when do they swing in your favor, you’ll receive higher payments.

Equity-Indexed Annuities

Woman counting money for annuity

Variable annuities can also come in different types such as equity-indexed annuities. With this kind of variable annuity, you won’t need to pick an investment since your annuity will be automatically tied to S&P 500 or a similar benchmark, which means that your payout amounts would be directly tied to the performance of the stock market. It also guarantees a minimum payout amount so you would have an idea of what you could make even if prices drop.

Deferred vs. Immediate Annuities

If you need to receive payouts as soon as possible, you can opt for an immediate annuity so you can receive payouts immediately after funding your account. It’s an excellent option for those ready to retire and are looking for guaranteed regular payouts. Or you can opt for a deferred annuity if urgency is not a concern. With a deferred annuity, you choose when you want to receive payouts. You invest in the annuity now, wait for it to grow and then withdraw from it when you retire. You can also defer your retirement taxes when you choose a deferred annuity. Also, for younger individuals who are considering their retirement plan options, deferred annuities can ensure that they receive payouts when they retire.

Annuities, whether variable or fixed, really offer an excellent option for supplementing your retirement savings. You just have to take into account your financial status and your existing retirement funds when selecting which type of annuity will suit your needs best. Just remember to keep a close eye on the benefits, risks, and fees of your chosen annuity to help make sure that won’t have to experience the risky side of annuities.