One of the most popular vehicles to help supplement retirement income today is the annuity.
An annuity is an insurance contract that you purchase from an insurance company; it is not an investment. Rather, the premium you pay offers a variety of guaranteed retirement income options depending on the terms of the contract.
The guarantees in the contract are not backed by the government or a bank, but rather by the financial strength of the insurer.
A Fixed Income Annuity (FIA) is one type of annuity that offers a limited benefit similar to investment market performance, combined with the advantages of guaranteed income. An FIA typically guarantees a modest fixed interest rate, but also enables your contract balance to grow based on a link to market performance. It also allows limited access to funds if needed.
The typical FIA offers the potential for you to earn additional retirement income based on the performance of a specific market index. Each year that index posts a gain, the FIA will “credit” a percentage of that gain to your annuity account. If the index stays flat or posts a loss, there will be no credit for that year – but your annuity account will not lose money either.
In fact, as long as you follow the requirements of the annuity contract – which may include provisions such as not withdrawing more than an allowed amount each year – your initial premium is guaranteed to provide a specific amount of income when you retire. Any additional credits provided by the linked index’s positive market performance will increase the amount of retirement income you will receive.
Be aware that all earnings received (beyond your initial premium) will be taxed as ordinary income in the year distributed. If you withdraw any amounts classified as earnings before age 59½, those amounts also may be subject to a 10 percent federal tax penalty for early withdrawals.
The nice thing about an FIA is that, as long as you follow the contract rules, you can benefit from some market performance without risking your principal. You also may have the option to purchase a rider (for an additional fee) that guarantees you’ll receive retirement income for the rest of your life, that of your spouse, and/or provide for loved ones upon your death.
The following are two types of riders available to purchase with an FIA contract.
Guaranteed Lifetime Withdrawal Benefit Rider
The guaranteed lifetime withdrawal benefit rider enables you withdraw a specific amount from your account each year for the rest of your and even your spouse’s life. This amount is guaranteed for life as long as you take no additional withdrawals once the annuity distributions begin.
The amount of income you receive is derived from the Benefit Base in your account. The Benefit Base is not an amount you can actually access; it is the amount earned over the life of the contract that is then used to calculate your lifetime annual benefit amount. This Benefit Base is comprised of your purchase payments and any interest credited to your contract each year on the anniversary of the day you purchased the contract. Your lifetime income benefit is calculated by multiplying the Benefit Base amount by a withdrawal percentage rate, such as 4 percent. The percentage is determined by a number of factors, including the age of the beneficiary(s).
Guaranteed Minimum Income Benefit Rider
The guaranteed minimum income benefit rider guarantees a minimum level of income once you begin distributions (subject to certain withdrawal and other restrictions) for life or for a specific time period, with the opportunity for that amount to increase.
Like most financial products, annuities offer both advantages and drawbacks. It’s very important to work with a financial or insurance professional to determine if an annuity is appropriate for your situation and, if so, which type of annuity would best suit your needs.