One of the oldest forms of financial products used for the purpose of retirement planning is an annuity. Because annuities provide tax-deferred savings, as do qualified individual retirement accounts, people often assume they don't make sense in an IRA. Notwithstanding the shared tax-deferral treatment, comparatively, annuities offer guarantees, flexibility and additional features that stocks, mutual funds and other financial instruments often purchased into IRAs can't offer.
Annuities were first introduced into the United States in the 18th century by insurance companies. They are a form of financial contract between an insurer and purchaser guaranteeing defined benefits. Annuities come in two forms -- immediate, which begin paying out right away, and deferred, which begin paying out at a future date determined by the purchaser. Deferred annuities can be purchased in a lump sum or periodically over time, enabling the purchaser to utilize annual IRA contributions to fund an annuity purchase.
One of the key benefits of an annuity is the guarantee of payments to the annuitant over a set period of time or over their lifetime, insuring them against the very real issue of outliving their income or assets. Stocks, mutual funds and similar assets provide no such guarantee. By purchasing an annuity directly into the IRA with annual qualified contributions, you reduce your taxable income, gain the benefit of tax-deferred savings and guarantee that some portion of your IRA will provide income over your lifetime no matter what happens to the remaining assets in the IRA.
There are three types of deferred annuities, providing an individual the flexibility to customize an investment approach within an IRA that is best suited to her needs and risk tolerance. Fixed annuities pay a set rate of return, much like a CD or bond, but they are guaranteed and pay out for a minimum preset period of time, if not the life of the annuitant. Variable annuities give purchasers the ability to invest in mutual fund shares, providing the individual with the opportunity to increase their retirement savings through market participation. Equity-indexed annuities pay interest tied to market indices, such as the Standard & Poor's 500 index, enabling the purchaser to garner enhanced returns in a rising stock market without direct investment in the market (up to a maximum capped amount, such as 8 percent), while providing the guarantee of a minimum income payment, notwithstanding annualized market performance.
For additional fees, you can attach extra features to annuities, referred to as "riders," that provide specific benefits not available with other assets purchased in an IRA. Examples include a death benefit rider that ensures the designated beneficiary will receive the full value of the annuity (or the total premiums paid if that amount is higher) in the event the annuitant were to die before payouts begin. Guaranteed minimum withdrawal and income riders are another popular option, ensuring that 100 percent of the premiums paid or a higher designated amount be paid to the annuitant, regardless of the performance of the underlying investments within the annuity.
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