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Annuities enjoy the same tax treatment as retirement funds. Many people transfer funds from old 401k accounts or Individual Retirement Accounts into annuity products. Annuities cater to people close to retirement seeking fairly conservative investments that offer some guarantees and higher returns than bank products. Very conservative consumers invest in FDIC insured certificates of deposits available through banks, rather than annuities.
Ultimately, most annuity contracts are geared towards creating an income stream during retirement. Insurance companies use mortality tables to determine monthly payment amounts, and after annuitization, most contracts provide income for life.
Fixed annuities provide principal protection; annuitants receive a fixed interest payment in return for depositing their money with the insurance company. Banks offer long-term certificates of deposit that work in the same way but are FDIC insured.
Variable annuities allow clients to invest in mutual funds but provide guarantees to cover losses in the event of market downturns. Variable annuities also feature death benefits that recoup any loss of principal if the owner dies during the term.
Purchasers of Immediate Income annuities pay a premium to an insurance company, which is immediately annuitized into a monthly income stream.
Fixed annuities generally offer higher rates of return than long-term, FDIC insured bank certificates of deposit (CDs). Many fixed annuity contracts provide some liquidity through penalty-free withdrawals of 10 or 15 percent of
the account value each year. Most states require annuities to offer money-back guarantees that enable clients to withdraw their initial investment without incurring a penalty to the principal.
Annuities cater to people who otherwise utilize CDs and bonds to generate income. Immediate annuities and variable annuities offer higher monthly payments than other income products.
Most fixed annuity terms are between 4 and 10 years. Standard variable annuity contracts involve a 10-year surrender term, although some companies offer terms as short as 4 years. Income streams from annuities offer payments based on mortality tables that assume everyone dies at age 100, but payments continue for people living past that age.
Since annuities benefit from tax deferral, withdrawals prior to age 59 1/2 cause negative tax ramifications for the owner.
People considering immediate income annuities or planning to eventually turn other annuities into income products should consider probable cost-of-living increases. Fixed-income products become problematic during inflationary cycles, and most investment companies advise clients to diversify their portfolio for that very reason. Additionally, although many states have provisions in place to assist customers in the event that an insurance company fails, the assets held in annuities are not backed by the federal government.
The FDIC provides coverage of $250,000 per person, per bank for all retirement accounts. Many people prefer federal guarantees rather than state regulations when it comes to preserving their money.