One way to either fund or help fund your early retirement is by purchasing a retirement annuity. Understanding Annuities before locking into a retirement annuity contract or policy is extremely important. That’s because retirement annuity contracts can be very costly to back out of later if you want to end your annuity arrangement.
Understanding Annuities, How does a Retirement Annuity work? What is it?
A retirement annuity is an insurance product. One where you hand over a chunk of money to invest in the retirement annuity type of your choice. Either paid for all at once or over a period of time making payments (investments).
The retirement annuity eventually pays out income to you using various payment options. The method and terms of your received payment depends on what flavor of annuity you purchased. Your income payments can come to you as a lump sum, paid out annually, quarterly, or the most common way as monthly payments.
There are a number factors that determine the size of the retirement annuity payment you will receive. Here are a few:
- Length of Payment Time-Frame. Your annuity payments can be set for the rest of your life or for a guaranteed number of years. Example, a guaranteed 10 or 15 year set payout.
- Fixed Annuity. You receive a fixed payout or income amount.
- Variable Annuity. Your payout is determined by your annuity’s underlying investment performance.
- Survivor Benefit Annuity. You can designate that payments continue after you die to your spouse.
- Single Life Annuity. It only pays out as long as you live.
- Investment Amount and Interest Rate. The amount of your investment and the going interest rates at the time of purchase definitely impacts the size of your annuity income payment.
Tax Advantages
There are tax advantages to retirement annuities because you can have them tax deferred. You can buy them with tax deferred money that you have in a 401K or IRA account. Just be aware that starting retirement annuity payments before age 59 ½ will trigger the dreaded IRS 10% early withdrawal penalty.
Annuities sound wonderful so far. But there are some things about annuities that turn most people off.
Retirement Annuity Turnoffs
- Your money is tied-up in an annuity for many years. If you try to prematurely take a withdrawal or cancel it there are high surrender charges. Those surrender charges can be 7% and possibly higher of your total annuity investment depending on the contract.
- Retirement Annuities usually have high fees associated to them. From the initial commission which can be as much as 10% of your investment. To paying ongoing management fees of 2% to 3% a year for a variable annuity. There can be many hidden fees too. They will eat into your annuity’s investment performance. Possibly even eating into your investment balance.
Retirement Annuity fee structures are complicated and may be hard to understand. When you are listening to all the wonderful things about having an annuity, just remember there are some cost related drawbacks.
Do take the time to read the fine print. Be prepared to ask a lot of questions before signing on the dotted line.
You can learn more about your protections and annuity details at the Securities and Exchange Commission Website.
Retirement Annuity Turn-on
One of the reasons people are drawn to annuities is they get a guaranteed payment. A fixed payment that will cover their monthly living costs. People want the income without having to worry about investment market conditions.
Retirement Annuity seekers are willing to accept the high costs of annuities in trade for sleeping better at night. For many people the emotional factors outweigh the high annuity costs.
Understanding Annuities is easier said than done because there is a lot to take in. You can get a feel for the various annuity payout types and the estimated monthly income with this free Annuity Calculator.
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