What annuities are and how they work
All annuities are designed to provide a guaranteed income stream for now, or in the future, but they work in different ways to help fund your retirement.
What is an annuity? It’s a binding contract to convert a large sum of money into a series of smaller, guaranteed payments.
How do annuities work?
There are several types of annuities, but they all work on the same basic principle. You pay one or more premiums to an insurance company that invests the money to generate returns, which generally grow tax-free. Then, the insurance company uses those funds to make regular payments to you for the period of time specified in the annuity contract – a fixed number of years or the rest of your life.
Do you want to start getting income now – or later?
If you are already at retirement age and want payments to start within a year, you should consider an immediate annuity – which is typically purchased with a single lump sum payment. Otherwise, you can purchase a deferred annuity – with either a lump sum or series of payments – and funds in your annuity will grow tax-deferred for one or more years until you start taking income.
Fixed immediate or deferred annuities
This is the most predictable type of annuity because it pays a guaranteed, fixed rate of return on the premiums you contribute. When you’re ready to take income, you receive a guaranteed stream of payments.
Variable annuities
These deferred annuities offer fewer guarantees on investment growth but let you take advantage of the highs and lows of the financial market. Any earnings are tax-deferred until you're ready to start receiving income payments.
Fixed index annuities
This is a deferred annuity that can provide both premium protection and market growth potential by providing a minimum guaranteed interest rate combined with potential growth tied to a specific index.
Registered index-linked annuities
A newer type of deferred annuity, also called a RILA, lets you take advantage of market growth up to a set cap, along with a level of downturn protection that you set based on your comfort level with risk.
Fixed immediate or deferred | Fixed indexed | Variable | RILA | |
Guaranteed income for life | ✓ | ✓ | ✓ | ✓ |
Tax-deferred growth | ✓ | ✓ | ✓ | ✓ |
Potential for market-like returns | ✓ | ✓ | ✓ | |
Level of protection against market losses | ✓ | ✓ | ✓ | |
Potential legacy for heirs | ✓ | ✓ | ✓ | ✓ |
Note: The benefits listed are generally available for the type of annuity noted but may not be included in a specific annuity holder’s contract: each contract is unique and tailored to the needs of the owner.
Annuities can provide tax advantages
When you buy an annuity, the funds you invest grow on a tax-deferred basis, meaning you don't pay ordinary income tax on the earnings until you withdraw or convert to a stream of payments (referred to as "annuitization" in your contract). This can provide a significant tax advantage if you're in a lower tax bracket when you start to make withdrawals – such as when you're in retirement. Another tax deferral benefit: unlike most retirement accounts, annuities don't have IRS contribution limits.
Once you start taking money out of your annuity, it will be taxed as income. How much will you pay? It depends on whether you bought the annuity with pre-tax or post-tax dollars. When it's bought with pre-tax dollars, all the money you withdraw is generally taxed as income. However, if you use post-tax dollars to buy the annuity, you'll only pay taxes on the earnings, not the premiums you paid in. You should also know that there may be IRS tax penalties if you withdraw from your annuity before age 59½, unless you meet one of the exceptions to the penalty rules. Before making any decisions regarding an annuity, you should seek specific advice from an independent tax, legal, or financial professional.
Why are annuity contracts typically written by a life insurance company?
Annuities are a way to guarantee – or ensure – that you have a stream of income that keeps on paying, no matter how long you live. When you purchase an annuity designed to last the rest of your life, you're essentially transferring the risk of outliving your savings to the insurance company. Regardless of how long you live (even beyond age 100!), the insurance company takes on a legally binding responsibility to indefinitely maintain the annuity payments specified in your contract. And in fact, some people end up getting far more out of their annuity than they paid in. Life insurance companies have experience managing that kind of risk, along with the actuarial and investment expertise needed to meet long-term payment obligations.
An annuity is a contract – and you need to pay attention to the details
These are some important things to consider when reviewing the contract of an annuity.
Annuities are not a liquid investment, which means that your money will be tied up in a contract, and each contract has different restrictions. And in most cases, you won’t be able to access money before age 59 ½ without incurring IRS penalties.
With some annuities, you can opt to cancel or "surrender" and receive the value of your contract; however, a surrender charge may be applied if your premium (the money you paid in) was in the annuity for less than a specified number of years.
Certain annuities may also come with annual or additional fees for optional contract features and/or optional riders.
Some annuities or annuity benefits may be based on market performance.
You'll also want to know what kind of financial rating your insurance company has, which indicates how financially secure the company is. You want to make sure you're purchasing from a trusted insurer, so you can feel confident the money will be there when you need it. Guardian Life Insurance Company of America continues to receive high ratings across the board.
As you're buying your annuity, make sure to ask your financial professional about the terms of any surrender charges, fees, optional features or riders and associated costs, as well as the insurance company's financial ratings.
Are annuities right for you?
An annuity can be an important part of your retirement planning strategy, along with 401(k) plans, pensions, whole life insurance cash value, and other assets. It can help you achieve a greater level of income stability, so that no matter how long you live, you won't outlive that stream of income. Every person's situation is different, but there's a simple way to determine whether to consider an annuity. First, add up all known regular expenses you'll have during retirement, then subtract other forms of guaranteed income, like a pension or Social Security. If there's a gap, then an annuity may be a smart financial option. If the income you receive from an annuity can cover your fixed costs, you can spend your other retirement savings with greater confidence.
Annuities can provide unique lifetime income benefits that protect against outliving your money, but they aren't for everyone. Most annuities have limited liquidity, which means it can be difficult to access the funds in the annuity without paying penalties. They can be more complex and harder to understand than other investment products, such as mutual funds, and may have administrative fees and other limitations that don't match your investment objectives. Some annuities may not have a death benefit, which means your heirs won't be able to get money out of the annuity if you've already started receiving payments. Other annuities (specifically, variable and RILA annuities) can lose value. And while annuitization can make converting retirement assets into a lifetime income stream easier, not everyone needs that. For example, if you have lifetime income from a pension or own tangible assets that generate reliable rent income, you may want to prioritize other types of investments or retirement savings.
It's important to carefully consider all the pros and cons of an annuity, including tax implications, before deciding whether it's the right option for your retirement needs. A financial professional can help you evaluate the costs, benefits, and risks associated with annuities and explore other retirement income options.
While fixed annuities guarantee a specific rate of interest, it is possible to lose money with other kinds of annuities, depending on the terms of the contract and the performance of the underlying market-based investments. However, it's important to note that many types of annuities offer guarantees that protect you from investment losses – for example, a fixed-index annuity offers the potential for growth tied to a specific index but also provides a minimum guaranteed interest rate that protects your principal and earnings during market downturns. Variable annuities, on the other hand, are tied to the performance of underlying subaccounts, which can lead to gains or losses. It's also important to know that some types of income annuities may not provide a "return of principal", which means that some of the initial investment may be lost if the annuitant passes away before receiving the full value of the annuity payments. That's why you should always carefully review the terms of the annuity contract with your financial professional, so you can understand the potential risks associated with the type of annuity you are considering.
Here’s a basic annuity definition: it’s a financial contract with an insurance company to provide a regular income stream in exchange for one or more upfront payments. It is typically used as a way to guarantee retirement income.
An immediate annuity starts paying income right after you pay the insurance company a lump sum of cash; Deferred income annuities (also called deferred annuities) can be purchased with a lump sum, or a series of premium payments, giving your money time to grow tax-deferred until guaranteed income payments start.
The payment amount you receive depends on several factors, including the type of annuity (i.e., a variable annuity or a fixed annuity) the initial amount invested, your age and life expectancy, and the interest rates and investment performance of the underlying investments. Annuities can provide a guaranteed income stream that helps to reduce the risk of running out of money in retirement.
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Do you need income now, or later? Learn about immediate and deferred income annuities
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Variable annuities (VA) and registered index-linked annuities (RILA) are long-term investment vehicles designed to help investors save for retirement and involve certain contract limitations, fees, expenses, and risks, including possible loss of the principal amount invested. The investment return and principal value may fluctuate so that the investment, when redeemed, may be worth more or less than the original cost. As with many investments, there are fees, expenses, and risks associated with these contracts. These contracts are sold by prospectus only. A prospectus may be obtained by calling 888-Guardian (888-482-7342) or downloaded at guardianlife.com. Please read the prospectus carefully before investing or sending money.
All guarantees, including the death benefit payments, are dependent upon the claims-paying ability of the issuing company and do not apply to the investment performance of the underlying funds in the VA. Assets in the underlying funds are subject to market risks and may fluctuate in value. You can not invest directly in an index with a RILA.
This material is intended for general public use. By providing this content, The Guardian Life Insurance Company of America, The Guardian Insurance & Annuity Company, Inc. and their affiliates and subsidiaries are not undertaking to provide advice or recommendations for any specific individual or situation, or to otherwise act in a fiduciary capacity. Please contact a financial representative for guidance and information that is specific to your individual situation.
All guarantees are backed exclusively by the strength and claims-paying ability of The Guardian Insurance & Annuity Company, Inc. (GIAC). Annuities are issued by GIAC, a Delaware corporation, and distributed through Park Avenue Securities LLC (PAS). GIAC and PAS are wholly owned subsidiaries of The Guardian Life Insurance Company of America (Guardian). Guardian, GIAC and PAS are located at 10 Hudson Yards, New York, NY 10001.
For more information about annuities, please contact your financial professional or call 888-GUARDIAN (888-482-7342).