The term “annuity” gets thrown around quite a bit in the financial world, especially when discussing retirement income strategies. But there is confusion around the word because, well, annuities are complex. In simple terms, an annuity is an investment and insurance hybrid, meaning it is a form of investment with a type of guarantee in it. Annuities are typically used for retirement savings or generating income during retirement. Still confused? Let’s break it down some more.

 

How do I get an annuity?

Annuities are sold by insurance companies, which allow you to set aside money in that annuity to let it grow over the course of a year without paying taxes on it. After a year of watching your annuity grow, you will then be able to make income on it by streaming payments for the future. These payments are taxed, just like your income from a job would be. However, unlike IRAs, there isn’t a limit on how much money you can put in an annuity.

 

How much money can I make with annuities?

Your annuity income can vary, but they do provide a great benefit, which is the large group of other annuity customers. Insurers can provide large returns to annuity holders because other annuity holders in the pool can subsidize even larger income streams when they die. And since insurers can’t predict the death of that many people in the annuity pool, the larger annuities potentially could benefit those who outlive them. So, there is a good chance your annuity can make you money for quite a while. However, it is important to note that not every annuity offers the same guarantees.

 

Can I get any tax benefits through an annuity?

Like stated above, when you first purchase an annuity, you can set it aside for a year and watch it grow without paying taxes on it. In addition, annuities can protect your tax returns from being taxed or defer taxes on your returns. While this sounds great, IRAs or a 401k might be a better fit for your needs.

 

Are there risks of purchasing an annuity?

While fixed annuities can eliminate the general risk of investment in the market, there are other risks that come with annuities that cannot go unmentioned or unconsidered. One risk to keep in mind is inflation. There are cost-of-living adjustments included in Social Security benefit plans, but that is not the case for the majority of annuities, thus reducing spending power of monthly payments throughout the annuity contract. Yes, there are annuities with cost-of-living adjustments available, but they are much more expensive.

Another risk that must be considered when purchasing an annuity is insurance company failure. There is always a chance that the insurance company you purchased an annuity from fails or shuts down. This would leave you hanging because private annuity contracts are not covered or guaranteed by the FDIC or SIPC. You can avoid this by dividing annuity contracts among a few insurance companies to stagger risk and gain more protection. Learn more about our services and how we can assist you in stress-free retirement planning at Mercurio Wealth Services.