If you're looking for a way to generate income in retirement, you may be considering purchasing an annuity. An annuity is a contract between you and an insurance company. In exchange for a sum of money, your annuity provider promises you a certain amount of income over a preset period of time.
While annuities have some disadvantages, and they tend to come with complex rules, they also offer certain benefits that other retirement products do not. Here are four annuity advantages to consider as part of your decision.
1. Predictable retirement income
When you put money into an IRA or 401(k), the amount of income you ultimately have access to in retirement will depend on the performance of your investments. As you're probably aware, the stock market in particular can be extremely volatile, and if your portfolio drops in value as retirement nears, you could find yourself with less income than expected.
With a fixed annuity, on the other hand, you're guaranteed a specific amount of income each month regardless of how the market is doing at the time. In this regard, an annuity can spare you from the risks associated with most investments -- and help you sleep better at night.
2. Tax-free growth
While a fixed annuity guarantees you a specific amount of income each month, a variable annuity pays you a certain amount of income based on the performance of your account's investments. And though you can't fund a variable annuity with pre-tax dollars, once that money is in your account, it gets to grow on a tax-deferred basis. This means that you won't have to pay taxes on investment gains until the time comes to take withdrawals. In this regard, annuities are similar to IRAs and 401(k)s.
But while traditional IRA and 401(k) distributions are always taxable in retirement, with an annuity, there comes a point in time when you're no longer required to pay taxes on withdrawals. Annuities are usually taxed on a last-in, first-out basis, so when you take distributions, the money that comes out is initially considered earnings -- and subject to taxes. However, once the value of your annuity falls below the amount you contributed to it, your withdrawals will no longer be taxed.
3. No annual contribution limits
Though IRAs and 401(k)s offer key tax benefits, they both limit the amount you're allowed to contribute each year. Currently, workers under 50 can put up to $5,500 a year into an IRA and $18,000 into a 401(k). Those 50 and older, meanwhile, can contribute up to $6,500 a year to an IRA and $24,000 to a 401(k). But while these limits are more than generous for some people, those who wish to save above these thresholds are bound to feel restricted.
The beauty of annuities is that they don't impose an annual limit on contributions. If you've already maxed out an IRA or 401(k) but want to invest more money in a tax-advantaged manner, an annuity can be a good solution.
4. Protection against outliving your savings
In a recent Allianz survey, 60% of baby boomers admitted that they were more afraid of outliving their savings than actually dying. An annuity, however, can protect you from what's apparently a fate worse than death. If you purchase a deferred-income annuity, you'll be guaranteed a certain amount of income at a specific point in time. So if, for example, you're planning to retire at 65 and are concerned that your retirement account will run dry by the time you reach age 85, a deferred-income annuity can pick up where your savings leave off.
While these annuity benefits make them a good choice for some people, annuities aren't for everyone. Not only can annuities be expensive as far as fees go, but many come with lengthy surrender periods, during which you'll face hefty costs for withdrawing funds early. That said, if you've exhausted your options for saving with an IRA or 401(k), an annuity can be a good way to generate the extra income you need to support your retirement lifestyle.