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Unsure About Annuities? Let’s Talk About the Basics

As 2022 starting to warm up with Spring weather, the discussion around the role of annuities in retirement planning keeps heating up. Based on a fluctuating market, more consumers are looking for ways to protect their hard-earned retirement dollars while wanting a financial product that accumulates more than standard banking CDs or savings accounts.

The other factor involves minimizing risk within the retirement plan and having additional guaranteed lifetime income to complement other retirement pieces like Social Security, 401(k), savings, and other assets. That’s why Annuity Alliance provides answers to questions on this website.

Are you unfamiliar with the basics of an annuity and what it does? Here’s a couple of common Frequently Asked Questions by annuity novices.

  • What is an annuity? An annuity is a contract between you and your insurance company that allows your earnings to grow and compound tax-deferred. Tax deferral is a powerful benefit you can use to help accumulate wealth for your retirement or meet other long-term financial goals. The word “annuity” literally means “annual payments.” Annuities are a popular choice for investors who want to receive a steady stream of income in retirement. The income you receive from an annuity can be distributed monthly, quarterly, annually, or even in a lump sum payment. The size of your payments is determined by a variety of different factors, including the length of your payment period.
  • What can an annuity do for me? Growth potential – A fixed index annuity has the potential for higher interest earnings than a traditional fixed annuity with a guaranteed minimum interest crediting rate. There’s also no direct downside market risk to your money. Your principal is protected from market fluctuations. Helps you sleep better – An annuity can help you save money on a tax-deferred basis and can guarantee you’ll receive income for life. So no matter how long you live, you won’t outlive your retirement income. Fills in the gaps – Sometimes pensions, IRAs, and Social Security don’t provide enough income for you to live the way you want during retirement. A fixed index annuity can help supplement your retirement income.
  • What are the tax advantages of owning an annuity? Under current federal law, annuities receive special tax treatment. Income tax on annuities is deferred, which means you are not taxed on the interest your money earns while it is within the annuity. When you buy an immediate annuity or “annuitize” a deferred annuity, a portion of each payment is considered earnings, and a portion is a tax-free return of your principal. Earnings are taxable as ordinary income when distributed or if withdrawn before you turn 59½, a tax of 10% may be levied. Once enough payments have been made, and you recover your entire tax-free principal, each additional payment will be fully taxable. There are other ways you can access the accumulated value in your annuity. For example, instead of annuitizing, you may want to take withdrawals. In that case, distributions represent taxable earnings first. After all the earnings are distributed, the tax-free return of principal remains. If your annuity is inside an IRA, 401(k), or other qualified retirement plan, 100 percent of each payment will be subject to taxes (unless a distribution represents after-tax contributions into the plan). You should consult your tax advisor regarding your particular situation. Annuity Alliance is not authorized to give tax advice, so please talk to your own tax or legal advisor to discuss your individual situation. If you’d like to discuss this further with a licensed Annuity Alliance specialist, please contact us.
  • Who can sell annuities? Annuities can only be sold by licensed insurance professionals who completed product-specific training. The agent must be a representative of the insurance company and must hold a valid insurance license in your state. Agents and representatives are compensated by the insurance company. No sales compensation is ever deducted from your annuity principal.

Do you still have some questions about annuities? You can learn more in Annuity Alliance’s Resource Center, which has answers to commonly asked questions. You also can contact Annuity Alliance to get connected with a financial professional in your local area.