An annuity is another tax-deferred way to save for retirement and receive lifetime income.
When you buy an annuity, you enter into a contract with a life insurance company. The company agrees to make payments to you and/or your beneficiary over your lifetime(s) or a set period, usually beginning at retirement. If you die before payouts begin, a death benefit is payable to your beneficiary. Contributions to annuities aren't tax deductible.
Like other retirement savings vehicles, annuities offer tax deferral on earnings from investments. But an annuity offers two features that most other types of savings plans don't:
You can structure an annuity to provide you with an income you can't outlive.
Annuities don't limit the annual amount you can contribute toward your retirement.
As with most other tax-deferred savings plans, you'll have to pay federal (and possibly) state income taxes on any earnings you withdraw from the annuity at or before retirement, and withdrawals before age 59½ may be subject to the 10% early withdrawal penalty. Also, surrender charges may apply if funds are withdrawn before the contract's surrender period is over.
Immediate or deferred income
Immediate annuities make payments to you soon after purchase.
Deferred annuities enable you to accumulate savings before receiving regular income payments. Taxes on earnings are deferred until your income payments begin.
Fixed or variable
Fixed annuities invest primarily in bonds and mortgages that offer fixed rates of return. They earn a guaranteed rate of interest for a specified period of time, and the interest rate is adjusted for each new period.
Variable annuities allow you to select underlying investment vehicles or subaccounts managed by professional money managers. Your investment value is not guaranteed and will fluctuate based on the performance of the underlying investments.
Any guarantee associated with an annuity is subject to the claims-paying ability of the issuing insurance company.