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Annuities: here’s what you should know

Annuities can provide the benefits of tax-deferred growth potential – and a guaranteed income stream throughout retirement.

But not everyone understands how they can fit into a secure retirement, so let’s find out what annuities do and how they work.

What is an annuity?

Annuities are a form of insurance and can only be issued by insurance companies. Whereas life insurance protects against the risk of dying too soon, annuities protect against the risk of living too long. Annuities are one of the few financial products that can guarantee an income you can’t outlive.

There are often two phases of an annuity – the accumulation phase and the income distribution phase, otherwise known as “annuitization.” You can use a lump sum to purchase an annuity or send payments on a regular basis and your contribution earns interest or investment returns. Earnings accumulate tax-deferred, which means taxes aren’t owed until money is withdrawn, which typically occurs at retirement.

At some point in the future, you may elect to turn your accumulated value into an income stream. When you annuitize your contract, you receive a guarantee on the schedule and duration of your income payments. You will likely have options to choose income for life or a set period of time as well as basing it on a single life or two lives (joint).

Types of annuities

An immediate annuity offers the opportunity to generate a guaranteed stream of income, starting within a year after purchase. Think of immediate annuities as “income now.”

Think of a deferred annuity as “income later” where you defer income to sometime in the future. There are three types of deferred annuities.

Fixed deferred annuities offer guaranteed growth at a specific interest rate, making them lower-risk and predictable.

Fixed indexed deferred annuities offer the opportunity to earn interest linked to the changes in performance of an index. Fixed indexed annuities offer protection from market downturns but still allow you to earn higher interest than you would with many fixed interest products.

Variable deferred annuities offer the ability to invest your contributions in variable investment options, making them a good fit for those who want market participation and are prepared to face market risk (and the ups and downs that go along with it).

Considerations when thinking about an annuity

Costs and liquidity are two primary considerations for annuities. Some annuities have a surrender period where you incur a penalty for taking money out or if a withdrawal is made prior to 59.5 federal tax penalties may apply. Once the surrender period is over, your liquidity options increase. Surrender period lengths vary so you want to make sure you understand and are ready to make a long-term decision. You will also want to have a good understanding of all fees related to your annuity as some are more expensive than others. 

Why buy an annuity?

There are several good reasons to purchase an annuity.

Perhaps you’ve maxed out your other tax-advantaged retirement plans, such as your 401(k) and IRA. With a nonqualified deferred annuity you can deposit as much money as you want — there is no legal limit (there may be specific product limits). 

If you’re close to retirement age, buying an annuity can help you feel a sense of security by providing a guaranteed income during your retirement years. 

Annuities aren’t what they used to be. Many of them now offer more liquidity and lower costs. In addition, you can usually purchase optional benefits (for an additional cost) to accommodate specific accumulation, income or legacy needs.

An annuity won’t take care of every financial retirement issue you’ll face, and they’re not a perfect fit for everyone. But they can go a long way toward making the financial side of retirement less challenging. 

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How do I purchase an annuity?

Our annuities may be purchased through a financial professional. To see how much you may need to save for retirement, use our easy-to-follow calculator.

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An annuity is intended to be a long-term, tax-deferred retirement vehicle. Earnings are taxable as ordinary income when distributed, and if withdrawn before age 59½, may be subject to a 10% federal tax penalty. If the annuity will fund an IRA or other tax qualified plan, the tax deferral feature offers no additional value. Qualified distributions from a Roth IRA are generally excluded from gross income, but taxes and penalties may apply to nonqualified distributions. Please consult a tax advisor for specific information. There are charges and expenses associated with annuities, such as surrender charges (deferred sales charges) for early withdrawals. Variable annuities have additional expenses such as mortality and expense risk, administrative charge, investment management fees and rider fees. Variable sub accounts of annuities are subject to market fluctuation, investment risk and loss of principal.

Some products and features may not be available in all states and features may vary by state. 

The guarantees are subject to the financial strength and claims-paying ability of the issuing insurance company. The guarantees have no bearing on the variable investment performance.

This information should not be considered tax advice. You should consult your tax advisor regarding your own tax situation. Guarantees are subject to the financial strength and claims paying ability of the issuing insurance company.

Variable annuities are sold by prospectus. You should consider the investment objectives, risks, charges and expenses of a portfolio and the variable insurance product carefully before investing. The portfolio and variable insurance product prospectuses contain this and other information. You may obtain a copy of the prospectus from your representative. Please read the prospectuses carefully before investing.

A purpose of the method of marketing is solicitation of insurance and that contact will be made by an insurance agent or agency.

DOFU 8-2022