What is an annuity?
Think of an annuity like a gift you are giving to your future self. At their core, annuities are a contract between you and and an insurance company wherein you give the insurance company a set amount of money that grows, tax-deferred, during an accumulation phase. After the accumulation phase, the insurance company begins paying you a set amount of money each month for the rest of your life. Annuities can help manage your finances after you retire by using the surplus income from your working years to supplement your income when you are out of the workforce.
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The two phases of annuities: ACcumulation and Distribution
Annuities help regulate cashflow after retirement. Their are two phases associated with the Annuity process: Accumulation and Distribution
Accumulation Phase: While you are still in the workforce, you will send money to the insurance company to fund the annuity. This can be done monthly, annually, or in a lump sum. You can also purchase and fund an annuity if you are not currently working. Essentially, an annuity simply needs cash to be funded and after that point, the details of the annuity will dictate when the Distribution Phase begins.
Distribution Phase: During the distribution phase, the owner of the annuity no longer contributes funds to the annuity. Instead, the owner begins receiving monthly sums from the insurance company for a period of years previously agreed upon or for the remainder of their lives or their spouse’s life. Actuaries calculate the amount of money sent to the owner based on many factors including age, gender, and the amount of the fully funded annuity itself.
The Different types of Annuities
Immediate Annuity: This refers to an annuity that begins monthly payments to you immediately after you fund the annuity. Immediate annuities can be useful if you have just inherited a sum of money and want to insure against spending it too quickly while still receiving financial support from it.
Indexed Annuity: This refers to an annuity that grows at a percentage tied to a major index (such as the Dow Jones Industrial Average). As the market grows, your returns will share in a portion of their gains. There is a floor associated with these gains so that if the market falters, you will not lose your investment.
Variable Annuity: This refers to an annuity that is directly invested in mutual funds or similar investment vehicles. While the potential gains are greater, you risk losing some of your investment should the market take a severe downturn.
Fixed Annuity: This refers to an annuity that returns at a consistent percentage regardless of market conditions. The returns may be low, but they are guaranteed and the gains are tax-deferred.
The bottom line: Annuities can help fund your retirement without liquidating other assets
Annuities can be an essential component of a sound retirement strategy. Through contributing to your annuity when you are making excess money, you are able to control your income after you retire. This allows you to live your best life even when you are out of the workforce without having to liquidate property and other valuable assets in order to cover your life expenses. Annuities are a forward-looking approach to how you want to live in retirement and can help offset taxes that incurred by placing your money in the market.
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