Annuities: A fresh perspective

Key Points

  • An annuity allows you to accumulate additional retirement dollars
  • Optional withdrawal benefits can provide the security of guaranteed income
  • Protected income for covering essentials is key to a confident retirement

As the number of corporate pensions continues to decline and uncertainty around Social Security’s future increases, finding sources of predictable and secure retirement income seems to be more elusive. But is it? An increasing number of retirees are turning to annuities to supplement government benefits and investments in the markets through a 401(k), IRA or other structured plans.

So, what is an annuity? In a nutshell, it’s a long-term retirement vehicle issued by an insurance company that can help you grow your money, take income in retirement and pass on your wealth.

Depending on your goals, risk tolerance and financial situation, there are different types of annuities that could meet your needs. With a deferred annuity, you choose a later date to begin withdrawing funds, while an immediate annuity provides a monthly income right away.

Within those two types, you can choose a fixed annuity with a set return rate (fixed interest rate) or a variable annuity that fluctuates along with the market. Variable annuities provide a guaranteed death benefit for your beneficiaries, as well as optional guaranteed benefits with growth opportunities and protection features for an additional fee.

Despite their increasing popularity, misconceptions around annuities persist. We asked Lynn Abbott, Vice President of National Sales and Funds Management at RiverSource, to shed light on some of the most common myths.

While retirees may use annuities for income, those who are still working can benefit too. “If you’re in your mid-to-late 40s, you do have the benefit of time and tax deferral for non-qualified dollars, which can help accumulate more funds in the annuity,” Abbott says. Because there are no annual or lifetime limits with annuities, those who’ve maxed out their 401(k)s or other tax-deferred vehicles are able to turn to variable annuities, which generally offer tax-deferred accumulation. This means you don’t pay taxes until you take withdrawals, giving your money more opportunity for growth.

One of the biggest benefits of a variable annuity for those still working is risk management. “Say that you’re planning to retire at age 65 and you’re 60 years old. If there’s a 10% market correction, there may not be enough years to be able to earn back where you were, let alone any additional accumulated value forecasted for age 65,” Abbott says. The other big risk is the possibility of a market decline happening after you’ve begun taking withdrawals from retirement investments, which could further erode your principal investment.

Those who’ve maxed out their 401(k)s or other tax-deferred vehicles are turning to non-qualified annuities as another way to save money without taxes cutting into growth.

A variable annuity offers you the opportunity to take advantage of market gains over time. Through the investment in variable subaccounts or asset allocation models, your contract value will change along with the market, making it a valuable long-term investment tool for those who can tolerate some level of fluctuation.

For those with less tolerance for risk, a fixed annuity offers growth potential at a set interest rate. “For clients who have a low risk tolerance, a fixed annuity may be a good choice because it credits interest and has a guaranteed minimum interest rate,” Abbott says.

Similar to an IRA and 401(k), annuity distributions of non-qualified earnings are taxed as ordinary income when they’re withdrawn. “The question frequently asked is if the taxation of an annuity as ordinary income is worth the benefit of tax deferral vs. paying the currently lower long term capital gains tax,” Abbott says. “The answer is that it depends on your individual situation — in some cases it may be.”

While account holders do incur fees associated with annuities, the benefit of added security may be worth it. Many workers remember the recession eight years ago, and they’re concerned with ongoing market volatility and uncertainty around financial legislation. An increasing number of investors are willing to pay a fee for certainty, according to Abbott. “By way of analogy, you have property insurance on your home that you keep even after your mortgage is paid off,” she says. “For most, your retirement is an even bigger investment than your home, so insuring your income-generating assets can make a lot of sense.”

Depending on your individual needs and goals, an annuity can be foundational to a more confident retirement by helping to ensure basics are covered. “Ameriprise advisors actually discourage investors from putting more funds into an annuity beyond what’s needed for essential income,” Abbott says. “You may want to work with your financial advisor to invest the rest of your savings for portfolio growth that may keep up with inflation and meet lifestyle income needs.”

With a variable annuity you will pay a Mortality and Expense (M&E) fee, which helps cover the guarantees the annuity provides. Variable annuity investors also pay underlying fund expenses and in some cases, an annual contract charge. A surrender charge may apply to withdrawals during the surrender charge periods.

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Your advisor can provide more insight into the various types of annuities available and how they could complement your overall financial plan.

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