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Annuities 101

This White Paper explains how an Annuity works, and how it can be a part of your retirement plan. Annuities differ greatly in how they work, so it’s important to identify the parameters of what would best suit your retirement goals. With the White Paper below, we hope you gain awareness of your alternatives when it comes to annuities.


An annuity is a financial product that allows an individual to receive a persistent income stream, either for life, or for a certain time period, during retirement. Individuals typically purchase an annuity in a lump sum, although the option to purchase an annuity through a series of payments also exists. An annuity behaves much like an IRA in that it accumulates tax deferred, but will face penalties from the IRS if distributions are taken prior to age 59 ½,


Accumulation Phase


Once an annuity is purchased, unless the annuity is a Single Premium Immediate Annuity (SPIA), the annuity enters the accumulation phase. During the accumulation phase, the value of the contract increases, or “accumulates,” depending on what type of annuity it is, what strategies were selected, and the performance of the selected strategies.


There are a variety of different types of annuities. Most commonly there are Fixed, Indexed, and Variable annuities, which cover the full range of risk vs. reward.


Fixed annuities declare a fixed interest rate which the annuity will return each year. They behave much like bonds, CDs, or money market accounts. A type of fixed annuity commonly referred to are MYGAs (Multi-Year Guaranteed Annuities). MYGAs can be attractive options if you want to lock in a high fixed return for a longer period of time, especially if you believe the interest rate environment will be lower in the future. As of June 2023, there are MYGAs that return 5.45% with 10-year rate guarantees.


Indexed annuities, sometimes referred to as fixed indexed annuities, are annuities whose performance can be linked to certain indices, such as the S&P 500. Indexed annuities offer downside protection from losses since they do not directly participate in the index. Through the use of options, the returns of indexed annuities are linked to the performance of the selected index strategy. The returns are either “capped” by a maximum percentage or a participation rate. If the cap of a selected index is 10%, then the largest annual gain possible is 10% for the owner of the annuity, even though the index may have returned 20%. However, if the external index goes down 10%, the value of the annuity does not go down and the return is 0%. With regards to participation rates, if a participation rate on an indexed strategy is 50%, then the owner of the annuity receives 50% of any gain. For example, if an index increases by 20%, the owner gets a 10% return. If the index loses value, the return is once again 0%. Indexed annuities often have several different indices to choose from. Over time, indexed annuities are expected to outperform fixed annuities.


Variable annuities are the riskiest of the different types of annuities. Linked directly to the market, variable annuities have the ability to lose value during market downturns. However, variable annuities do have the greatest growth potential. Variable annuities typically have a large variety of funds to choose from.


Annuitization Phase


Once the owner of an annuity is ready to receive income, they would annuitize the contract. The contract would now be in the annuitization phase. The amount received each month/year would depend on the accumulated value of the contract, and the time period of desired income selected, whether the annuity is single/joint life, and the company the annuity is from. An income period of 10 years would likely result in a larger monthly/annual annuity payment than an income for life selection. Some annuities also offer residual death benefit to beneficiaries if the annuitant passes earlier than expected, and some offer full or partial payments to the spouse of the owner. Inflation adjusted income streams, among other features, can at times be selected.


Other Annuities


As previously mentioned, there are SPIAs, or Single Premium Immediate Annuities. These annuities skip the accumulation phase and enter the annuitization phase immediately. SPDAs or Single Premium Deferred Annuities are most commonly placed in the Fixed Annuity category. Be sure to analyze the features of your proposed annuity to ensure that it aligns with your financial goals.


With future Social Security benefits potentially in jeopardy, an annuity could be a great addition to your financial portfolio. If this sparked your interest, be sure to reach out to speak with one of our trusted advisors.


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