An annuity is a retirement savings product. Annuities are another way to get tax-deferred growth or earnings outside of IRAs or employer-sponsored retirement plans. If an individual is looking for additional ways to save for retirement, an annuity can provide additional income upon retirement.
Annuities are sold by life insurance companies and considered to be an insurance product. Any guarantees or benefits provided by the annuity contract are the obligations of the insurance company and not backed by any government insurance. Although they are sold by life insurance companies, they do not have a life insurance benefit. The most a beneficiary will receive is the deposits to the contract plus any earnings that have accumulated. The safety of the annuity is based on the safety and stability of the issuing insurance company.
Deferred annuities earn interest until the annuity owner, or annuitant, is ready to receive retirement income from the contract. The earnings received by the annuity grow tax deferred until withdrawals are made. Fixed annuities earn a rate of interest determined by the insurance company. The rate is usually adjusted once a year by the insurance company to reflect current interest rates. Variable annuities have separate accounts that hold stocks and bonds like a mutual fund. The growth of these accounts is also tax deferred.
Annuities are retirement savings products, and there are tax penalties if the earnings are withdrawn before the annuitant reaches age 59 and a half. Early withdrawals are subject to regular income tax on the earnings plus a 10 percent tax penalty. Withdrawals after age 59 and a half are subject to regular income tax rates.
Annuities have no upfront sales charges or commission. The full deposit to an annuity goes to work earning money. Annuities do have withdrawal fees that the insurance company will keep if money is withdrawn during a certain period, usually five to seven years after the annuity is purchased. Withdrawal fees are in addition to any taxes or tax penalties that may be due when money is taken out of an annuity prematurely.
A unique feature of annuities is the different income options available when the owner reaches retirement age. An immediate annuity pays a regular income, usually monthly, to the annuitant. A deferred annuity can be converted to an immediate annuity, or a lump sum of money from another source can be used to purchase an immediate annuity. Income options include a lifetime income that will last as long as the annuitant is alive and cannot be outlived. Other income options combine the lifetime income with survivor income for a spouse or a guarantee of income for a certain number of years if the annuitant does not live that long. Immediate annuities can also be set up to pay an income for a set period of time, such as 10 or 20 years. Once an income option is selected, it cannot be changed. An annuity owner also has the option to withdraw the money as a lump sum from a deferred annuity rather than selecting an immediate annuity payout option.