You want a steady income stream during retirement — and an annuity may be just the ticket. But first, you need to understand annuities and their many choices. Basically, an annuity is a contract with an insurance company that promises a certain amount of money on a periodic basis for a specified time. Your contributions have tax advantages; investment earnings grow tax-free until you start withdrawals.
There are two varieties:
Other broad categories are fixed, indexed and variable annuities:
What's the tax story?
What are the tax benefits of annuities? During the accumulation phase, your earnings grow tax-deferred. You pay taxes only when you start taking withdrawals. Withdrawals are taxed at the same rate as your income. If you're funding your annuity through an individual retirement account or other tax-advantaged retirement plan — what's called a qualified annuity — you may be entitled to a tax deduction for your contribution.
When the money comes out
Once you decide to start the distribution phase, your insurance company will calculate your periodic payment amount by using a mathematical model. The most common choice is to receive monthly payments for the rest of your life or for the rest of your spouse's life as well.
There is something of a gamble with an annuity; if you live for a long time after you start taking distributions, you could receive a lot more money than you ever put into an annuity. But if you die soon after you purchase it, you won't get your money’s worth. So, you may want to add another provision: a guaranteed number of payment years. If you and your spouse die before the period is over, the insurer will pay the remaining funds to your heirs.
This is just an introduction to a complex topic. Before buying an annuity, consult with an independent financial professional to see if an annuity is right for you —and if it is, what kind is best.
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