What are Retirement Annuities
Retirement annuities are one more option an individual investor has for saving for retirement. Retirement annuities function similarly to a traditional individual retirement account in that they grow tax-deferred while the investor is able to contribute earned income. But instead of an investor having to manage the money he or she has accumulated over the years once retirement age is reached, the retirement annuity owner can guarantee monthly income without having to worry about a loss of principal or managing the amount of money within the account.
Retirement Annuity Details
Just like standard annuities, retirement annuities can be purchased with incremental payments or with one lump-sum payment known as a single premium. When purchased with incremental payments, an investor can usually choose to contribute monthly, quarterly or annually, depending on whether or not the annuity is part of an employer sponsored defined contribution plan or a plan that is set up directly with an insurance company.
Retirement annuities that are set up as part of an employer plan such as a 401(k) are funded with qualified money. Qualified refers to the fact that the contribution is made with pre-tax dollars, or dollars that are not taxed until the money is returned to the investor. All qualified money grows tax-deferred until the investor begins to receive distributions. Distributions from qualified retirement accounts cannot begin before age 59 ½ and must begin by age 70 ½.
If an investor has contributed the maximum amount allowed to his or her employer plan and wants to save additional money for retirement, he or she can do so with post-tax, or non-qualified money. Non-qualified money is money that has already been taxed. It can be earned, and now part of a savings account, or it can be acquired by other means such as through the sale of property or an inheritance.
What are the Advantages of Retirement Annuities
The difference between traditional individual retirement accounts and retirement annuities is the way the payouts are structured once the individual reaches retirement age. With an individual retirement account, investors are required to withdraw an amount each month as dictated by Internal Revenue Service based on the amount of money that has been accumulated within the account and current life insurance company longevity projections.
For example, if a male investor begins taking withdrawals at age 70 ½, the amount he must withdraw each year is based on the amount of money in each of his retirement accounts and his life expectancy, which is currently estimated to be 78 years of age in the United States.
Retirement annuity payments, however, are determined at the time the contract is written. While the amount of each payout may be based on life expectancy if the investor chooses guaranteed payments for life, it is not based on the value of the account. In other words, individual retirement accounts are assumed to have a finite value whereas annuities are not. Individual retirement accounts can be depleted. Retirement annuities with guaranteed payouts for life cannot. Therefore, the risk of outliving one’s money is far greater with only traditional individual retirement accounts.
The owner of a retirement annuity in effect transfers the risk of outliving his or her money to the insurance company. One further advantage of retirement annuities is that there is no limit to the number of annuities or the dollar amount of each that an investor can own.
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What are the Disadvantages of Retirement Annuities
For investors without enough cash reserves that can be accessed in an emergency, a retirement annuity may not be the best choice. Also, investors need to ensure that they select a financially stable insurance company, as retirement annuities represent liabilities that must be funded 20, 30, 40 or more years in the future. A.M. Best, Moody’s Investors Services and Standard and Poor’s all provide free rating information that places a value on the ability of an insurance company to meet its future financial obligations. Investors are always advised to seek out companies that have the highest possible ratings.
Further, investors should always make sure that their financial advisors are not only licensed in the state in which they do business, but are also licensed to sell the products they are selling. For example, a person who sells variable retirement annuities must be licensed by the state to life insurance and by the Securities and Exchange Commission (SEC) to sell securities.
Investors are also often concerned about the possibility of death occurring soon after annuity payouts begin. While in the past this could mean that an investor’s money would not be available for his or her heirs, today almost all insurance companies offer to offset this risk. Many retirement annuities can now be purchased with a rider that allows for a beneficiary to either receive the total premium amount minus the payouts or to receive the balance of the payouts.
For example, a retirement annuity that guarantees that the beneficiary will receive the remaining principal will pay the beneficiary $250,000 of a $300,000 annuity if only $50,000 has been paid out. Or, the contract can be written to pay the beneficiary the guaranteed amount per month (or per quarter or per year) for the remaining time frame if the original annuitant chose to be paid for a set period of time rather than his or her lifetime.
Who Should Buy a Retirement Annuity
Investors concerned about outliving their savings should consider a retirement annuity. And, investors who would rather leave money management to professional money managers rather than having to do it themselves can also benefit from a retirement annuity.
Who Should Not Buy a Retirement Annuity
A retirement annuity is not suited for a retiree who cannot both fund the annuity and maintain savings enough to cover emergency expenses. It’s always important to remember that a retirement annuity represents an irrevocable contract. While some life insurance companies do offer a 30-day free-look policy that allows the purchaser to cancel the contract without penalty within 30 days, after that time is over, the contract cannot be changed.
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