If you are considering the purchase of an annuity for retirement income, you’re not alone. With traditional pensions becoming more and more scarce, investors who are looking to replace the steady stream of income in retirement are finding that annuities are one of the only products that can provide one. But not all annuities are alike, and before signing on the dotted line, it’s crucial that you do your due diligence in educating yourself on the options.
One option is the flexible premium deferred annuity, which offers a way to invest in an annuity without having to pay a large premium upfront. Often, those who purchase this type pay an initial premium payment followed by additional payments at their own pace. There is no set schedule, and the annuity grows with payments and accumulated interest. While immediate annuities offer payments that begin within one year of purchasing, payments on a deferred contract begin at a later date.
Flexible premium deferred annuities are guaranteed and grow on a tax-deferred basis, meaning you won’t pay taxes until you begin receiving payments. You can schedule payments, control the taxes on earning and take payouts as a lump sum or over time. But like any other financial product, there are both pros and cons.
Advantages of a Flexible Premium Deferred Annuity
Single-premium annuities require a large lump-sum payment, but with a flexible premium deferred annuity you can fund it at your own pace. If you purchase one when you’re in your 30s or 40s, you’ll have several decades to pay premiums and build value before retirement. This can be a great option if you haven’t quite reached your peak income earning potential. A flexible premium deferred annuity can be purchased with as little as $25 up front, which pales in comparison to the $1,000 or $2,000 required to invest in a mutual fund. You can then contribute to it as much as you like over time.
There are some disadvantages however.
The annuity company could limit contributions during the accumulation phase while your money grows with interest. Investors who view themselves as aggressive may not reach their goal if the cap is too low. Additionally, the annuity’s growth requires consistent payments. You can’t grow your principal investment without contributions. Therefore, flexible premium deferred annuities are best for someone who can pay premiums consistently over time. If you have a long enough window before retirement, even small contributions can add up.
If you have enough cash on hand to make a one-time premium payment, a regular deferred premium annuity might be a better option. Among regular deferred annuities, a fixed annuity offers a guaranteed rate of return while an indexed annuity bases returns on the performance of an underlying stock market index. Additionally, a variable annuity higher reward potential but with that comes more risk.
As with any purchase of a retirement income product, talking with your trusted financial advisor is always recommended. It is extremely important to understand how much annuity fees cost, what the money you use to purchase an annuity is invested in, how those investments may perform over time and the tax implications you should expect once you start receiving payments. You may also want to consider how to pass on annuity benefits to your spouse or loved ones.
An annuity is just one tool you can use in planning for retirement. Contact AnnuityFYI to find out more about how annuity products can help you prepare for your financial future.
Written by Rachel Summit