USA Today posted an article today about the four types of annuities and admitted that, while they aren’t the best game in town, they’re the only vehicle, outside of pensions and Social Security, to guarantee a lifetime flow of income in retirement (and you could argue the guarantee-ness of your company’s pension and Social Security). I’ve written about fixed income and variable rate annuities in the past and this post looks to expand on the basics introduced by that post.
To recap, an annuity is a contract with an insurance company that sets up a pension-like income stream for the consumer. In addition to fixed income and variable income annuities, there are two additional versions: fixed deferred and variable deferred. I’ll just discuss the deferred versions since the immediate ones have been covered before.
According to USA Today, Deferred variable annuities are the most complex of the four and should be a last resort for investors (if you’ve maxed out everything else). You can think of them as a mutual fund inside an insurance policy. So your money grows in the stock market as it matures, if you die before you start withdrawing money, then an affordable life insurance provision pays out a guaranteed amount to your heirs that is at least equal your investment. There are significant drawbacks to a deferred variable annuity. The fees cost about 2.3% of assets compared to an average fee of 1.3% with a regular mutual fund. The annuities also tie up your money for a minimum period of time, up to 15 years, and will impose a hefty fee, up to 15%, if you want to take your money out.
Deferred fixed annuities grow at a set interest rate, adjusted every few years, and you can withdraw the money in this annuity in one lump sum or as a stream of income, your choice. Unfortunately, you can’t withdraw your funds until you reach 59.5, or face a 10% penalty.
Also, some withdrawals from both deferred fixed and variable annuities count as a “return of your principal.” That means it’s not taxed (because this money was taxed going in). That is also important if you’re drawing Social Security benefits. Up to 85% of your Social Security payouts may be taxed if you have other income, but annuity principal doesn’t count in this calculation.