By providing a steady source of income you can’t outlive, annuities reduce the risk that you run out of money in retirement. Annuity.
There are many types of annuities out there, but stick to the simple ones and focus only on the guarantees.
Blueprint Income has a detailed Annuity Decision Guide that you can download for a more thorough read.
Annuities 101: The Basics
An annuity is a lifetime income guarantee that you purchase from an insurance company as a way to reduce the that you run out of money in retirement. Just like you insure your home, you can insure your longevity by passing on the risk that you outlive your savings to an insurance company.
There are many ways to fund an annuity — years before retirement, at retirement, over time, etc. — but they all provide you with the same thing: a guaranteed, steady lifetime-income stream when you retire that simplifies your retirement spending and offers peace of mind that you will not outlive your savings.
All annuities are built on this core concept; however, annuities can be complicated by various features, bells, and whistles that make them harder to understand, challenging to evaluate, and, in our opinion, less valuable. The article below is an overview of the types of annuities on the market today.
Annuities 101: Is It Right For You?
An annuity may be right for you if:
Affordable term life insurance rate
Your Social Security and/or pension benefits are not enough to cover your regular expenses,
You have already started saving for retirement,
You are in above-average health and hope to live a long life, or
You are seeking greater certainty in retirement.
Annuities, are not, however, designed to be the totality of your retirement nest egg, as they don’t provide everything you need in retirement. In particular, they do not have the potential to provide high stock market returns, and they are typically not indexed for inflation.
Annuities 101: Immediate Annuities
The immediate annuity, a.k.a. single premium immediate annuity or SPIA for short, is the simplest annuity product on the market. It’s purchased by people retiring within the next year or already in retirement. For a given amount of money paid upfront today, you receive an income stream starting within one year that lasts as long as you live. It is common for the annuity to cover both you and your spouse’s lives, where the income payments will continue as long as either spouse is alive, albeit at lower income stream.
To learn more about immediate annuities, head to this article.
Annuities 101: Longevity Annuities
Similar to the simple annuity, longevity annuities, a.k.a. deferred income annuities or DIAs for short, provide lifetime income in exchange for payments made 2-40 years in advance. In the longevity annuity, however, you simply delay receiving these payments for a period of 2-40 years. Because of the deferral, you will receive a higher income stream and are able to include additional payouts to the contract (learn more about this feature here ), longevity annuities can be good for people who want income starting years in the future.
Within the longevity annuity category, there is a special type known as a qualified longevity annuity contract or QLAC for short. The QLAC is a way to purchase a longevity annuity using your qualified retirement savings (such as from an IRA or 401(k) rollover) but delays the start of that income to after age 70½. It’s given this special designation because it overrides the IRS required minimum distribution (RMD) rules.
To learn more about longevity annuities, head to this article.
To learn more about qualified longevity annuity contracts, head to this article.
Annuities 101: Fixed Rate Annuities
A fixed rate annuity, a.k.a. a multi-year guaranteed annuity or MYGA for short, is an insurance company’s version of a certificate of deposit (CD). While CDs are great for low-risk short-term savings, fixed rate annuities are more suited to retirement savings, offering: higher crediting rates over longer time horizons, tax-deferred growth, the ability to annuitize upon maturity, and liquidity via penalty-free partial withdrawals. With a fixed rate annuity, you can invest your savings over a specified time horizon (typically 3 to 10 years), earning a fixed return. The interest earned in your fixed rate annuity is not taxed until withdrawn, and your principal is guaranteed.
Learn more about fixed rate annuities from in this guide.
Annuities 101: Market Linked Annuities (Variable Annuities and Fixed Index Annuities)
Historically, annuities existed purely to provide the guarantee of income for life as a way to protect against longevity risk. But, in the interest of making them easier to sell, insurance companies adjusted the product to include market-linked features and liquidity. These products, namely variable annuities and fixed indexed annuities, then purport to provide guaranteed income, exposure to market upside, protection from market downturns, and access to your funds if you changed your mind. While a single product that contains all of these features may sound appealing, they are hampered by high fees and limited efficacy. These annuities are a jack of all trades (and master of none) whose complicated fee structures dramatically limit market upside and reduce the amount of income you receive. Moreover, fixed indexed and variable annuities offered by insurance companies may be lower rated than standard income annuities. We strongly recommend against the purchase of these products! You can simply allocate some of your retirement assets to lower cost and safer immediate and longevity annuities, and use portion of your remaining assets to invest in low-cost funds, which provides greater higher market upside with minimal fees.
Annuities 101: Summary
At its core, an annuity is a valuable retirement tool that helps reduce the risk that you or a loved one run out of money in retirement. Because of this protection, annuities are first and foremost an insurance product. You should only buy an annuity – or any insurance product for that matter – for its guarantees. By limiting yourself to a simple annuity structure, such as the immediate annuity and longevity annuity, you can maximize this value of this guarantee! This article serves as a good first step by providing a high-level overview of annuities, now take the next step by consulting our longevity calculator and online resources.
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