• An annuity is a contract where you’ll receive a series of payments, typically lasting your entire lifetime, in exchange for a sizeable sum of money.
  • Annuities may help you hedge against economic downturns by ensuring you’ll continue to receive distributions regardless of how the markets are performing.
  • You can add riders to customize most annuities with desirable features such as death benefits or increases for inflation.

Retirement is not the time to run out of money. If you want to ensure that you’ll continue to have enough income to provide for your living expenses throughout retirement, then you may want to consider an annuity.

Here’s what you need to know and how to determine if an annuity is right for you.

An annuity is a contract between you and an insurance company where the insurer agrees to send you regular payments (i.e., distributions) in exchange for a regular payment (i.e., the premium). These payments may begin immediately or sometime in the future, depending on the type of annuity you’ve purchased.

For some consumers, annuities may offer the following advantages over other types of financial instruments:

  • Ingresos garantizados: Unlike other retirement plans where withdrawals may be based on investment performance, annuity payments are guaranteed by the insurance company. Regardless of market performance, you'll receive your payments.
  • Tax-deferred growth: Annuities are tax-advantaged. As with a traditional 401(k) or IRA, you won’t pay taxes until the distributions begin.
  • Passive maintenance: Annuities may be an excellent alternative for retirees who prefer to be hands-off with their nest eggs. The annuity provider will do the “heavy lifting” of investing the premiums and converting them into reliable, regular payments.

How Do Annuities Work?

The basic concept of annuities is fairly straightforward. Here's how the process works.

Determine the Type of Annuity You’d Like

Annuities come in all shapes and sizes. Some offer fixed payments, while others allow for potential increases over time. You may also be able to customize how long the payments will continue, whether there’s a death benefit, and more.

Annuities typically function in two phases:

Accumulation: You contribute money through a lump sum or periodic payments but do not start payments.

  • During this phase, the invested money grows on a tax-deferred basis. The growth can be based on a fixed interest rate, the performance of a market index, or investments in sub-accounts depending on the annuity type. No withdrawals are typically made during this phase. The accumulation phase can last years, depending on the contract and your timeline.

Distribución: The annuity pays you income, either for a specified term or for life.

  • While some individuals do not utilize this phase, this is when the annuity begins to pay you income. The distribution can be structured in several ways: a guaranteed income for life, a fixed period, or until the contract value is exhausted. Payments may begin immediately or at a future date. The amount of income depends on the annuity type,  the value, payout rates or riders elected, and payout options selected.

Choose Your Annuity Provider

Because an annuity is a major financial commitment and a significant component of your long-term planning, you’ll want to partner with someone you can trust. PNC offers a variety of reliable solutions for its clients.

Pay Your Premium

You can purchase an annuity with a lump sum payment or through a series of installments. Once your payment is received, the annuity provider will pool your investment with other participants to ensure that payment obligations can be fulfilled for everyone.

Collect Your Payments and Relax

Most annuity contracts are designed to provide you with payments for the rest of your life. However, you can also customize them to pay out over a specific number of years or even extend beyond your passing with ongoing payments to your spouse.

The majority of annuities make distributions monthly, but they can also be delivered quarterly, semi-annually, annually, or in lump-sum payments.

Types of Annuities

Annuities can be based on payment structure, start date, and how long the distributions will last. There are Fixed, Indexed and Variable Annuities. Here's a closer look at the key characteristics.

Payment structure generally falls into one of three main categories. [1]

  • Fixed annuity: Payments are always the same. The annuity provider guarantees a specific fixed interest rate and calculates a set monthly payment based on the premium. Distributions typically do not adjust for inflation unless you purchase a rider. Principal is fully protected and is not affected by market performance.
  • Indexed annuity: Payments may fluctuate over time. Premiums will be are generally invested into a common stock market index such as the Standard & Poor’s 500 Index. However, as the market goes up and down, your distributions may vary within a pre-defined upper and lower boundary, allowing for some relative consistency and easier planning. Similar to fixed annuities, principal is fully protected.
  • Variable annuity: Similar to indexed annuities, payments may fluctuate over time. In this case, the annuity provider allows you to invest some or all of the premiums into a variety of pre-selected mutual funds (similar to a retirement account). As these investments grow with the market, your distribution amounts can too. However, your payments may dip during economic downturns.

Annuity Features

Annuity contracts can be customized through the use of optional features called riders. Riders are add-ons that provide additional benefits, typically for an extra cost. 

  • Income Riders: Guarantee a minimum level of income for life, regardless or market performance. This would differ from Annuitization.
  • Death Benefits Riders: Provide beneficiaries with enhanced payouts, without underwriting.
  • Long Term Care Riders: Offer supplemental benefits to cover long term care cost.

Immediate vs. Deferred Annuities

Another major trait of annuities is when the payments begin.

  • Immediate annuities: Distributions start right away. These types of annuities are perfect for someone who’s already retired and wants to convert a portion of their nest egg into immediate, guaranteed income.
  • Deferred annuities: Distributions start at a later date. These types of annuities work great for someone who's a few years away from retirement or who wants to pay for their annuity in installments.

Lifetime vs. Term Annuities

Thinking ahead, you’ll also need to decide how long you’d like to receive your annuity payments.

  • Lifetime annuities: You’ll receive distributions for your entire lifetime, regardless of how long you live. These are the most common type of annuity arrangement.
  • Term annuities: Distributions will only last for a pre-determined length of time, typically between 10 to 30 years. At the end of the term, the payments stop, even if you’re still alive.

Choosing the Right Type of Annuity

There are many aspects to consider before finding an annuity that’s right for you. For example, you might choose an immediate, indexed annuity with lifetime benefits if you want semi-guaranteed payments with some opportunity for growth. On the other hand, you might choose a deferred, fixed annuity with a 10-year term if you’re currently 50 years old and want to receive payments from age 60 to 70 (when Social Security benefits will be at a maximum). [2]

Are Annuities Taxable?

Some or all of your annuity distributions may be subject to taxes. The specifics depend on how the annuity was funded and how the IRS classifies it. [3]

  • Qualified annuities: These are funded with pre-tax dollars, such as the funds from a 401(k) or traditional IRA. Since this money was already tax-deferred, the entire distribution (the initial investment plus any earnings) will be taxable as ordinary income.
  • Nonqualified annuities: These are funded with income that’s already been taxed. Since taxes have been paid on the initial investment, only the earnings portion of the distributions will be considered taxable as ordinary income.

Annuities Considerations

There are several important aspects to consider before making annuities a part of your retirement plan. Here are a few key considerations.

Benefits of Investing in Annuities

  • Guaranteed income stream: Annuities can provide you with much-needed income even when the economy is going through tough times. These reliable assets often serve as the foundation of a strong retirement plan.
  • Tax-deferred growth: Not having to pay taxes on your earnings may help them grow uninhibited for decades when compared to other options for saving.
  • Customization: Whether you want payments to increase with inflation or to continue to another family member after you've passed, you can customize an annuity to fit your particular needs.
  • Potential for higher returns: Not all annuities require you to agree to equal monthly payments. Some variations allow for potentially higher payouts as the stock market does well.
  • Death benefits: Most annuities allow you to purchase an add-on that pays a death benefit to your family. This enables the annuity to also serve as a supplementary life insurance policy.

Potential Annuity Downsides and Risks

  • Cargos: Annuity expenses are typically greater than the cost of managing an IRA or 401(k). Annuities can come with a range of fees. It’s important to understand what you’re paying for. Some annuities ten to have low or even no explicit fees. Others may include higher cost due to investment management, mortality and expense risk, and optional riders.
  • Complejidad: Annuity terms sometimes have a reputation for being unclear, particularly in situations where the payments are adjustable.
  • Liquidez limitada: Depending on the annuity type, there can be limitations to accessing the premium. Some annuities once annuitized, cannot be accessed. While others, may have a waiting period referred to as a Contingent Deferred Sales Charge (CDSC). This can limit the ability to have full access to the funds without a penalty. 
  • Inflación: Generally, annuity payments are fixed and will not automatically adjust with inflation. Unless you purchase a rider, the purchasing power of your distributions will gradually decrease over time.

Annuities vs. Other Retirement Options

Many retirees have used annuities to replace or supplement other retirement plans such as a 401(k), IRA, or Roth IRA. Here's how these options compare:

  • Beneficios fiscales: Annuities and retirement plans offer tax benefits, depending on the type of plan you choose.
  • Income: Like pensions, annuity distributions are guaranteed, while most other retirement plans are not.
  • Administración de inversiones: Most annuities are hands-off, while retirement plans traditionally require you to choose your own investments and regularly evaluate their performance.
  • No matching contributions: Many 401(k) plans offer employer matching contributions. Annuities do not have this feature.
  • Potentially higher fees: Annuities are generally more expensive than 401(k)’s and IRAs.
  • Estate planning: Unless your annuity comes with a rider for beneficiary benefits, the distributions will stop once you pass away. If beneficiaries are properly designated, then the remainder of your 401(k) and IRA balances will pass on to your heirs.

Is An Annuity Right for You?

Annuities may provide some much-needed financial security, but they’re not a good fit for every situation. If you’re considering adding an annuity to your retirement plan, ask yourself the following questions:

  • What are my income needs? Will trading some or all of my nest egg to purchase an annuity provide enough money to cover my living expenses for years to come?
  • How important is it to have guaranteed income every month regardless of market performance?
  • How comfortable am I with investing? Am I the type of person who can pick their own funds and evaluate their performance, or would I rather have someone else manage the investment side of the equation?
  • Do I want to leave a financial legacy? Given that most annuities cease distributions after death, am I content with my heirs forgoing these funds?

Para concluir

Annuities can be a great solution for those seeking financial security and a consistent source of income. However, they can be expensive and feature complex fees and payment structures. Consider the potential benefits and drawbacks to determine whether an annuity will enhance your retirement plan.