What Is a Retirement Annuity Contract?
Annuity policies are insurance contracts. These insurance contracts are meant to help you build a retirement savings and guarantee you an income. Retirement annuities are specifically designed to generate an income for you during retirement. These annuities are also known as immediate annuities. Before you purchase a retirement annuity, make sure you understand how these contracts work.
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Function
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Immediate annuities function by converting a savings to monthly payments. In order for a retirement annuity to work, you must already have a savings that you want to convert to payments. The savings is invested by the insurance company and earns interest. This interest, along with your original principal, is then returned to you as guaranteed monthly payments that last for your entire life or for a set period of time, whichever you prefer.
Significance
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The significance of a retirement annuity is that the annuity constitutes mostly a return of principal with a small amount of interest added to the payment. Many times, the interest factor does not amount to more than three or four percent per annum.
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Benefits
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The benefit of a retirement annuity is two-fold. First, the return of your principal amount means that only a portion of the annuity payment is taxable. Since annuities are taxed at ordinary income tax rates, this has the effect of lowering the amount of tax you pay on the annuity. Secondly, retirement annuities guarantee an income to you. This means you never have to worry about running out of money during retirement. You get the peace of mind of knowing what your income will be.
Disadvantages
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The disadvantage to a retirement annuity is that it is difficult, and in many cases impossible, to reverse the annuity payments and get your original savings back if you change your mind about having annuity payments. Some retirement annuities offer a refund option, but many do not. Once the annuity payments start, you must continue receiving them until the contract has matured and all payments have been made.
Considerations
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Before you buy into a retirement annuity, you should carefully weigh the consequences of this type of annuity. Consider using only part of your retirement savings for the annuity instead of converting all of your savings. This allows you to keep some of your savings invested in the event that you need a large lump-sum of money in the future.
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