Some Basics on Annuities and Income

Considering An Annuity?...Read This First!

There are several different types of annuities:

  • Immediate or Income
  • Fixed
  • Variable
  • Equity-Index


Already Retired?......Income Annuities

Also known as immediate annuities, life annuities or payout annuities.

Income Annuities guarantee a specified amount of income each month in exchange for a lump sum payment.  These annuity income payments begin immediately and last until death or for some set period of time, typically between 5 and 25 years.

The insurance company pools this money from all the contract holders and pays out each month depending on your age, sex and current interest rates.  The older you are, the bigger the monthly payout. You will get a larger income stream because of shorter life expectancy.  

Your IRA or 401k money can be used to purchase these annuities.  This money which has come from a "qualified" plan will be subject to ordinary income tax as it pays out.  Payments from immediate annuities can be used to cover recurring expenses-such as mortgage payments or long term care insurance premiums or simply to supplement income.

This is the type of annuity current retirees should consider if they need income.

There are some definite advantages for retirees:

  • Retirees can create their own pension.  Traditional employer pension plans are disappearing and many people will have an income gap.
  • Annuities create immediate income that never fluctuates and depending on how it is structured can never be outlived.
  • You could potentially increase the cash flow in retirement as the annuity returns investment income and also a portion of the income.

How an Income Annuity Pays Out

Here's what a typical $100,000 life immediate annuity will pay out monthly

65 year old man, single annuity......................................................$639

70 year old woman, single annuity......................................................$675

70 year old man and woman, joint and survivor.....................................................$585

Rates will vary from state to state, these are for California residents.


Fixed  Annuities

Fixed annuities carry a set interest rate, very similar to a CD investment.  These annuities may offer a bonus rate the first year and a interest rate floor the following years.  Generally the fixed annuity has surrender charges-that means you'll be penalized for withdrawing early.  Many of these annuities are offered for 5 or 7 years.  This type of investment may be suitable for retirees and can be offered inside of a IRA account.   Compare the interest rate on the annuity with current money markets or CD rates to see if the annuity has an advantage.

Variable Annuities...Saving for Retirement

A Variable Annuity is a tax-deferred retirement account offered by insurance companies. Like an IRA, your money will grow tax free until you start withdrawing the money.  If you withdraw money before age 59 1/2 you'll get hit with a 10% penalty on the amount you take out.  The annuity will offer "subaccounts" as investments-these are mutual fund like investments managed by familiar fund companies.  These investments will fluctuate depending on the market.  Unlike an IRA, you can put in as much money as you like and there are no contribution limits based on your income.

There are some advantages and disadvantages to the variable annuity.  The real benefit is deferring taxes and the ability to "annuitize".  Annuitization allows you to create an income stream after retirement.  There is also a death benefit.  If you die, your heirs get at least the amount you contributed to the annuity.  These annuities are appropriate for younger investors who have contributed to employer plans and IRA's and want to save additional money for retirement.

A variable annuity is not appropriate for IRA accounts and should not be used to "rollover" employer plans.  The IRA is already a tax shelter and the extra fees for an annuity will reduce your long term returns.

Equity-Index..Newer Version Annuity

This type of annuity is sort of a hybrid between a fixed annuity and a variable annuity. When you purchase an equity-indexed annuity, the issuer agrees to pay a return on your account that is tied to a stock market index--usually the S & P 500. However, the issuer also guarantees to pay you no less than a certain return in a given period if the return on that stock market index falls below that minimum percentage. Thus, if stocks do well, you earn above-average returns on your annuity, and if stocks fall in value, you will not lose money (as you would with many variable annuities).

Check the Credit Rating

Once you decide on the type of annuity you want, check the rating of the annuity with one of the agencies that monitors these type of investments.  There are several including Standard and Poor's, Moody's Investor Service Inc., Fitch and A.M. Best.

Helpful Annuity Terms

Annuitize  To exchange a lump sum for a lifetime stream of income.

Single Life Annuity  An annuity that covers only one  person only.  The annuity contract owner will receive a lifetime stream of payments until she or he dies.

Joint and survivor annuity   Lifetime payments continue through your lifetime and your spouse's lifetime.

Surrender Charge  Fee or penalty for taking money out of annuity.  Annuity contracts often have 6-8 year time frame before funds can be withdrawn without penalty.

Death Benefit  The amount your beneficiary will recieve if you should die before receivng payments.

Exclusion Ratio  How much of your deferred annuity is taxable.  The orignal investment in the annuity is "after-tax" money and isn't taxable as it's withdrawn.

Period-certain annuity  You receive payments for aset period, rather than for life.

Mortality and expense charge (M&E)  An insurance fee charged by variable annuities.

GMWB Guaranteed Minimum Withdrawal Benefit  This feature allows investors to withdraw 5-7% of their initial contribution per year.  The feature is known as a "rider" and is tacked onto the annuity and typically costs between .30-.60% of account value each year.