A variable annuity can help guarantee income in retirement. Here are five reasons why—plus how to stay aware of the many details.
You have access to a multitude of financial products that can help you save for your retirement. So why consider a variable annuity? Because annuities in retirement planning can offer different features than other investments and help balance your retirement income strategy.
Think of it as part of building a “floor” for your retirement income—an amount of money you can rely on each month that won’t fluctuate with economic volatility. If you can piece together Social Security, an annuity, and possibly other sources of guaranteed income to cover your needs, the market swings of your investments have less impact on your retirement income.
However, keep in mind that you may need to pay more—perhaps a few percentage points more in annual fees—for the sort of guaranteed income you want. Always consider the tradeoff between affordability and reliability. Only you (and your financial professional, if you have one) know the cost you’re willing to pay to guarantee a certain retirement income as part of your holistic financial plan.
Let’s start with the two basic categories of annuities:
- Variable annuities invest in market-based subaccounts that go up and down with the market, which tends to mean greater growth potential and risk, and your balance will vary day-to-day. They may cost more than a mutual-fund IRA, because there are costs for the annuity structure and underlying investments. The more flexibility (death benefit protections, etc.) you add to the basic shell of the annuity, the more it may cost.
- Fixed annuities tend to be more conservative and provide a guaranteed interest rate for a specific period (typically three, five, or 10 years). When that time is up, the annuity renews at the market’s current interest rate.
Now, here are the five reasons variable annuities may fit into your retirement plan:
1. You can purchase a variable annuity with tax-deferred assets.
How do you fund an annuity? You can purchase an annuity with money from your savings or investment account. If you use qualified money from your 401(k) or IRA to purchase an annuity, your money will continue growing tax deferred. Some variable annuities allow you to make additional premiums, offering you a tax-deferred investment opportunity with no IRS contribution limits. (If the annuity is an IRA, the IRS contribution limits still apply.)
2. Variable annuities give you control over your investments.
Variable annuities offer market-based investments through subaccounts. By investing in annuities for retirement you can choose which subaccounts to put your money in. And if your goals change you can move your money in and out of subaccounts generally without tax consequences or additional fees.
3. Variable annuities help grow your money tax-deferred.
The money you contribute to a variable annuity grows tax-deferred. Gains made within the account are reinvested—and tax-deferred—which compounds growth. Taxes on your investment gains aren’t applied until money is withdrawn. (Also, if using nonqualified funds for your annuity, any distributions include a return on your investment—so, you don’t pay tax on the full distribution.) But consult a tax expert: As with other tax-deferred retirement accounts, there can be penalties for early or unscheduled withdrawals. Depending on your financial situation, you may not realize a tax savings when annuity funds are converted from capital gains to ordinary income at the time of withdrawal.
4. Ensure guaranteed income for life with variable annuities.
A variable annuity allows you to convert a portion of your investments into a stream of guaranteed income that’s protected from market volatility. Money not converted to guaranteed income remains invested for further potential growth. By creating a guaranteed, steady income stream, you can set up annuity payments for life or for a set period, depending on your needs. Guaranteed lifetime income means you can’t outlive your money.
5. Create a financial legacy with variable annuities.
A variable annuity also could provide greater financial security to your loved ones when you’re gone. Variable annuities provide death benefit features that don’t require underwriting. Plus, proceeds pass outside of probate (if the estate isn’t the beneficiary). But, again, keep in mind that greater security usually costs more. You can pay to add a “rider” onto the annuity to guarantee a certain level of income during your lifetime, or to guarantee a certain payment to your beneficiaries when you die.