Why Buy An Annuity? (Top 6 Primary Reasons For Buying Annuities)

So you've heard of annuities, and you've heard that they can be an invaluable part of your retirement plan. But you're not quite sure if you need one, and if you do need one, you don't know when you should buy it. There are plenty of reasons you'd want to buy an annuity contract.

Annuities are valuable for both accumulating money before retirement and distributing money in retirement. The prime reasons to buy a deferred annuity are that it provides tax deferral, principal protection, and significant growth compared to traditional savings products.

The primary reason to buy an immediate annuity is its ability to provide guaranteed payouts and lifetime income.

If you still find yourself asking, "Why should I buy an annuity?" Don't worry; you've come to the right place. Here's why you should buy an annuity, and when to buy an annuity, and the primary reasons to purchase an annuity.

Annuity Basics: What is an Annuity?

An annuity is a contract between you and a life insurance company.

There are different types of annuities, and each helps meet a buyer's individual needs. However, experts agree that there are generally two phases to most annuities: accumulation and distribution.

You can buy a deferred annuity to help accumulate money before you retire. When you are ready to receive your guaranteed annuity payments, you select from annuitization options which vary from periodic payments for a period of time or for the rest of your life.

A core reason for buying an annuity contract is the ability of the product to provide guaranteed payouts and lifetime income.

An annuity is a contract between you and a life insurance company. There are different types of annuities, and each helps meet a buyer's individual needs.

However, experts agree there are generally two phases to most annuities: accumulation and distribution.

A deferred annuity is the first phase—it helps you accumulate money before you retire. And an immediate annuity is the second phase—it distributes annuity payments to you in retirement.

Fixed, Indexed, and Variable Annuities

When you buy an annuity product, you also choose its relative risk level. This is where you decide between a fixed, fixed indexed, or variable annuity.

Fixed Annuities

A fixed annuity is the most conservative annuity product there is. When you buy your annuity contract, you select a specific period of time. Then, the insurer locks you into a fixed interest rate for that period.

That means, no matter how volatile the stock market is during that fixed period, you're always earning at the same interest rate.

Indexed Annuities

Indexed annuities don't have fixed rates like fixed annuities do. Instead, you choose from one or multiple market indexes and your crediting rate will be determined by their performance.

One popular index is the S&P 500. Your contributions are tied to these markets, and you earn interest based on their performance.

Indexed annuities have a minimum and maximum rate of return. So, if the market does poorly, the minimum guarantee protects you from losing money. But if the market does well, your growth caps at the maximum rate.

Variable Annuities

Of all the annuity types, variable annuities are the most volatile. They have the highest potential upside and downside. With a variable annuity, you choose from a list of investment options called sub-accounts. When these accounts perform well, your balance grows.

When they do poorly, your annuity loses value. Variable annuities are by far the most complex. Therefore, we recommend consulting with a financial advisor before purchasing one.

How Are Annuities Taxed?

Let's review some annuity tax basics. Your annuity will have different tax implications, depending on the type of annuity you purchase.

If you use pre-tax money to buy an annuity, it's considered a qualified annuity. When you receive distributions, you will have to pay income tax on the entire distribution. This is because you didn't pay any taxes on the initial funds, and you haven't paid taxes on the earnings. People tend to fund qualified annuities with a rollover from an IRA, 401(k), or other tax-deferred retirement accounts.

Conversely, you purchase a non-qualified annuity with money that you've already paid taxes on. When you receive payouts from a non-qualified annuity, you only owe ordinary income tax on the earnings.

This is because you've already paid taxes on the principal. There is only one case where your stream of income could be completely tax-free.

That's if you fund your annuity with a Roth IRA or Roth 401k. In this instance, you use after-tax money to buy the annuity, and the earnings grow tax-free if you meet certain timing and age requirements.

Because of the relative complexity of tax treatment of annuities, you may want to consult a tax attorney before purchasing a Roth IRA annuity to avoid any tax penalties.

When and Why to Buy an Annuity

Now that we've discussed what annuities are, let's cover when and why to buy an annuity. There are two major reasons why you would want to buy an annuity.

The first is if you're preparing for retirement. The second is if you need periodic income during retirement.

Before Retirement

As you prepare for retirement, it is a good idea to have various investments in place. If these funds are consistently growing, you can use them to help you with retirement income. That way, you'll be able to attain your desired future lifestyle.

Retirement planning should include an analysis of all types of products, including those that require you to pay annual taxes on interest-generated gains. These include mutual funds, savings accounts, CDs, and non-IRA stock portfolios.

Your financial retirement plan should also include tax-deferred products, like 401ks, IRAs, annuities, and other products that allow you to grow money on a tax-deferred basis. With these types of products, you only pay taxes when you receive distributions, usually in retirement.

A deferred annuity can be a great part of your pre-retirement portfolio of products. Interest rates on annuities tend to be higher than traditional savings products, and, as we mentioned, the tax deferral feature allows you to pay taxes on the gains only when you are ready to distribute the money.

Fixed annuities specifically are the most conservative type of annuity, yet offer interest rates that are usually significantly higher than other conservative investments like savings accounts and CDs.

In Retirement

According to the American Society of CPAs, "Of all the concerns impacting Americans' retirement today, running out of money, maintaining their lifestyle and rising healthcare expenses continue to top the list." This is not surprising due to fewer pension plans and a healthcare system that places more cost burden on the customer.

The amount of income generated by traditional sources (like social security) may not be enough to guarantee your desired retirement lifestyle. When you enter retirement, you must make some important financial choices.

You will need money to fund your lifestyle and cover expenses like healthcare, travel, mortgage payments, long-term care, food, utilities, and more. Consider purchasing an annuity as part of a comprehensive retirement plan. Annuities can supplement money you receive from other sources, like social security and pension payments.

Because annuities are life insurance products, they are uniquely crafted to help fund retirement expenses. An annuity is the only product that can provide guaranteed lifetime income. Many retirees fear that they will outlive their retirement savings—an annuity is the solution.

If you need to begin receiving income immediately, you would want to purchase an immediate annuity. An immediate annuity provides you with monthly income for a specific period of time in exchange for an initial lump-sum payment to the insurer. They’re called “immediate” annuities because you begin receiving annuity income payments almost immediately after you deposit your money.

This income guarantee makes annuities an attractive option as part of a well-rounded retirement plan.

Consider an immediate annuity as you enter retirement if you’re ready to begin creating income for yourself immediately. But make sure you ask lots of questions before signing the immediate annuity contract. There may be lots of fees to watch out for, and once you’ve purchased an immediate annuity, you cannot recover that money. Because of this lack of liquidity, it’s best not to invest all of your retirement savings in an immediate annuity.

6 Prime Reasons to Consider a Deferred Annuity Before or During Retirement

So, the core reasons for building retirement savings with a deferred annuity are:

1. Guaranteed returns (fixed annuities)
2. Principal protection (fixed annuities and indexed annuities)
3. Money grows tax-deferred
4. Higher rates and more significant growth than traditional bank savings products
5. Potentially flexible withdrawals during the guarantee period (usually 10% per year without surrender charge penalty)
6. Lifetime income with annuitization - annuitization provides guaranteed monthly payments and can prevent you from running out of money in retirement

Are Annuities For Everyone?

The answer to this question may be obvious: No, annuities may not be for everyone. But an annuity can provide significant benefits when part of an overall personal finance strategy for accumulating and distributing assets.

While growing assets before retirement, deferred annuities can be an effective product. Their guaranteed and above-average returns (especially for fixed annuities) can be an important piece of the financial planning puzzle. And then, when you’re ready to receive lifetime income, you can annuitize and provide yourself with peace of mind.

An immediate annuity is unique in its ability to provide guaranteed income, starting right away. Along with social security payments, an immediate annuity can be the foundation of your post-retirement financial plan. If you are searching for a deferred fixed annuity with great rates and simple terms, check out Canvas Annuity’s products. At Canvas, our annuities have some of the highest crediting rates on the market.

Plus, you can apply and buy your annuity directly online without the hassle of working with an insurance agent. Also, you can roll over your non-qualified or qualified retirement plan into either of Canvas Annuity’s products.

Apply today!

Citations

CNN Money (Sahadi, 2018) -- Before Choosing an Annuity, Know the Tax Implications 

AICPA 2019 -- Going Broke Remains Top Concern in Retirement: Survey of CPA Financial Planners