One of the things that you can do for your stress-free retirement is to make sure that you have enough savings and other income sources to live a comfortable life without having to sacrifice things and activities you enjoyed before becoming a retiree. 

However, with how unpredictable the market is, as well as the possibility of unexpected global events that could cause you to dive into the money you saved up (just like what we saw happening with the COVID-19 pandemic), that can become a daunting task.

Of course, you might say – “But what about my pension? Wouldn’t it be enough?” In an ideal world, yes – however, the truth is that plenty of Americans don’t even have access to employer-provided pensions, never mind it being high enough to be able to live life at an acceptable standard. 

According to data from November 2021 provided by the Bureau of Labor Statistics, only 15% of private sector workers had access to an employer-provided pension, also known as a defined benefit plan.

You can see why it’s important to also consider other options aside from savings and/or pension when it comes to your life after retiring and securing your financial future.

A solution that is steadily increasing in popularity are annuities – and there are several reasons for that.

What Is a Retirement Annuity?

A retirement annuity is nothing more than a contract between a retiree and an insurance company, which states that after making an initial investment, be it a lump sum payment or a series of installments, the retiree has the right to receive a guaranteed lifetime income until their death.

Typically, people purchase an annuity a few years before they are expected to retire and just wait to start receiving payments until it’s time for them to actually go on retirement. However, it’s also possible to do it once you’re already a retiree or are close to being one.

Types of Retirement Annuities

There are three main retirement annuity types – fixed annuity, variable annuity, and fixed indexed annuity.

With a fixed annuity, you know straightway how much retirement income you can expect – things like the stock market performance will not affect it, so it gives you a clear image of how your financial situation will look once you become a retiree. Instead, your money grows at an interest rate decided on by the annuity provider.

A variable annuity, on the other hand, can fluctuate throughout the annuity term. With variable annuities, you have a number of different stocks and bonds that you can invest your premium (what you paid to receive the annuity later on) in. Your payout will depend on how the subaccounts you chose perform, which means that you can’t really predict how much you will receive once you start receiving your guaranteed income.

While it is a better option in the sense that it allows you to grow your money when done right, it also comes with a lot more risk, and you might find yourself losing part of your initial investment.

The final option you have are fixed indexed annuities. Those are fixed annuities in which your initial investment grows along with a stock index it is associated with, such as S&P 500. One of the benefits we need to mention here is that even if the index performs poorly, you will not be losing money. That’s because an index annuity guarantees that the least amount of interest you can earn in a contract year is 0%, even if something as significant as a market crash happens.

Retirement Annuities - When Will You Receive Income Payments?

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Depending on your specific policy, your income payments begin either within a year of purchase (which is also known as an immediate annuity), or you can decide on deferred income annuities, in which case you can choose at which point your payments will start. It’s important to note, however, that with immediate annuities, a lump-sum payment is required. A deferred annuity is usually the go-to option for those who still have a few years to go before they are able to retire, while immediate annuities are preferred by those who are on the verge of retiring.

How Long Will the Payments Last?

That’s another thing you can decide on when it comes to your retirement annuity. You have the option to choose whether you’d like to receive the guaranteed income stream for a specific number of years (period certain annuity) or until your death (lifetime annuity). It’s important to notice that a period certain annuity will pay out for a specific number of years regardless of whether the person who signed the contract is still alive.

What Happens After You Die

Depending on the retirement annuity you chose, there are a few things that can happen after you die.

If you opted for a period certain annuity, as we already mentioned, your retirement annuity will be paid out for the number of years you agreed upon when signing the contract – typically 10 or 20 years. If you pass away during that time, the guaranteed monthly income doesn’t stop – instead, the payments go to the beneficiary you named when signing your retirement annuity.

If you chose the income for life annuity, and you die while your annuity is still in the accumulation phase (meaning the payments haven’t begun yet), most insurance companies provide an annuity death benefit to the beneficiary.

If you got a joint annuity with your spouse, and one of you dies, the other spouse will continue to receive payments until they pass away too. Depending on the contract, the amount they receive will either stay the same or will decrease.

Finally, if you are the only one to sign the annuity and you pass away during the payout stage, the payments simply stop – that is, unless you haven’t added a death benefit, in which case the remaining amount will be paid out to your beneficiaries.

What Is a Guaranteed Lifetime Withdrawal Benefit?

The guaranteed lifetime withdrawal benefit (GLWB) is a rider that can be added to variable annuities. While you will need to pay an additional fee for it, it protects your investment by ensuring that even if market downturns happen, reducing its cash value, you will still receive the minimum payout level.

Is a Retirement Annuity Taxable?

Annuities grow on a tax-deferred basis, which means that you don’t have to pay taxes on them until you start receiving payments.

Generally speaking, annuities can be divided into two categories – qualified annuities and non-qualified annuities.

  • Qualified retirement annuities are annuities that have been founded by pre-tax dollars, usually using an employer-sponsored retirement plan such as an IRA or a 401(k).
  • Non-qualified retirement annuities are founded on money that has already been taxed, such as a wage from a job.

So, how is a retirement annuity taxed? Income from an annuity is taxed with an ordinary income tax, which means that you will pay the same amount of tax on it as you would with any other income.

Qualified annuities are taxed on the whole amount you withdraw. For example, if you receive an annual payout of $20,000 from your retirement annuity, the whole $20,000 would be subject to tax.

Non-qualified retirement annuities, on the other hand, are only partially taxed – specifically, you only pay taxes on the earning portion of the withdrawal. How much that is, is calculated using an exclusion rate. The way it works is that you take the amount that you invested in the annuity and you divide it by the expected payout – the result will be a percentage. This percentage determines how much of each annuity payment is considered to be a return on your original after-tax investment. The rest will be considered your earnings or gains on your investment, and it will be subject to tax.

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The Bottom Line

More and more people are starting to worry about their future income once they become retirees and whether they’ll have enough retirement savings to live comfortably while not working. Considering how unstable the market can be, these are all valid concerns. It’s also part of the reason why retirement annuities are becoming a more common choice for many people when it comes to retirement planning.

Annuities provide them with a guaranteed income that allows them to live with peace of mind that once they stop working, they will be able to continue living as they were when they were working.

Jeremiah Konger
Jeremiah Konger
CEO at Annuity Association

Jeremiah understood his whole life the importance of community and caring for those who are a part of it. Starting his first business venture at the age of 23, he gained invaluable experience in working with others for a joint purpose.
He founded his first wireless retail business in 2011, expanding it from one store to 12 locations across the state in just three years.
Once he sold his company, Jeremiah began the journey he’s on today, using his talents and experience to work with seniors in order to help them find the best means of financing their retirement plans.

He’s found his true calling working as a proud member of the Annuity Association, assisting retirees in building their safe financial future.