What is an Annuity? A Way to Turn Savings into Income

Learn about fixed and variable annuities and how you might use them to help turn your retirement savings into income for life.

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Key Takeaways

  • Calculate the monthly income needed to help you sustain your standard of living in retirement
  • Consider annuities as a potential source of retirement income
  • Narrow down the possible annuity choices based on your goals, risk tolerance, and income needs

Throughout your working life, you’ve focused on saving money for the future. Now it’s time to switch gears and focus on how you’ll turn your savings into income that may potentially need to last 30 years or more. According to the Social Security Administration, about one out of four people age 65 today will live past age 90, and one out of 10 will live past age 95.

Planning now for lifetime income may help allay any fears of outliving your savings. And as part of this plan, you might want to put a portion of your money in an annuity.

Annuities: Insurance for Your Future

Like pension plans and Social Security, annuities offer the potential for lifetime income, which you could use to help meet your everyday needs in retirement. This steady stream of money could supplement your 401(k) or IRA savings and potentially free up the money in those accounts for other things such as travel or unexpected expenses. The payments are usually made monthly and the amount you receive depends on many factors, including your account balance, life expectancy, and the type of annuity you select.

Choosing Your Annuity

Knowing when you want annuity payments to begin may help you narrow down your choices. If you want to start receiving income right away, an immediate annuity might make the most sense for you. With a deferred annuity, you purchase it now and the payments start at a designated date in the future. This means your money has an opportunity to grow tax deferred. You don’t pay taxes on any earnings until distributions begin.

Income-Planning-Worksheet

 

Several things may influence your start date, including how much you have saved in other sources, such as an IRA or employer-sponsored retirement plan, and your anticipated expenses in retirement. For example, depending on your situation, you might elect to defer payments until age 80 when you may need the money to help pay for long-term care. To help you in your decision-making, check out the Income Planning Worksheet (see figure 1).

Once you’ve identified your time frame, the next step is to decide which type of annuity payment you want to receive: fixed or variable. Depending on your goals and investment preferences, one might be more appealing than the other.

Fixed Annuity
Variable Annuity
Reason to consider
  • You want guaranteed fixed payments for life.
  • You want the opportunity for growth and regular income payments.
How it works
  • You earn a set interest rate that's locked in for a specific period of time and guaranteed by the insurance company.

  • Your money is invested in a sub-account (similar to a mutual fund) so payments vary based on market performance.  
Potential benefits
  • The interest rate won't fall below a certain level. 
  • Payments aren't affected by market volatility.
  • Budgeting could be easier because you'll know exactly how much money you'll receive. 
  • Payments may increase during upturns in the market.
  • The opportunity for growth may help you manage rising costs in retirement, such as medical expenses.
  • Many companies guarantee a minimum payment to provide some downside protection.
Potential concerns
  • Payments might not keep pace with inflation, unless your contract includes a cost-of-living provision.
  • Guarantees are tied to the financial stability of the insurance company. 
  • Market fluctuations could cause payments to be lower than expected. 
  • You might not receive income for life, unless you purchase an income rider. 
Cost

Possible fees and expenses include:

  • A commission, if you purchase through a financial professional
  • Surrender charges, if you withdraw your money early
  • Fees for any riders

Possible fees and expenses include:

  • A commission, if you purchase through a financial professional
  • An annual fee (known as the Mortality & Expense risk charge)
  • An annual investment management fee for the underlying investments (also known as the expense ratio)
  • Fees for any optional income riders or other benefits 
This table provides a high-level overview of annuities. It's not comprehensive. Additional requirements or restrictions may apply. 

You don’t have to pick just one type of annuity. Based on your financial situation, you might decide it makes sense for you to allocate some of your savings to an immediate fixed annuity to help pay your monthly bills and to put another portion in a deferred annuity to help cover future expenses. The choice is yours.

Sense of Security    

Increased life expectancies and medical advances mean your retirement years could last as long or longer than your working years. That's why it's important to create a plan for turning your savings into lifetime income. Having this plan may help you feel more confident you'll be able to enjoy the lifestyle you want in retirement.

 

A Good Fit?

Let’s find out if an income-generating annuity might make sense for you.

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All investments involve risk, including loss of principal. Past performance does not guarantee future results. There is no assurance that the investment process will consistently lead to successful investing.

Annuities are long-term investments designed for retirement purposes. Withdrawals of taxable amounts are subject to income tax and, if taken prior to age 59½, a 10% federal tax penalty may apply. Early withdrawals may be subject to withdrawal charges. Optional riders are available at an additional cost. All guarantees are based on the claims paying ability of the insurer. An annuity is a tax-deferred investment. Holding an annuity in an IRA or other qualified account offers no additional tax benefit. Therefore, an annuity should be used to fund an IRA or qualified plan for annuity features other than tax deferral. Product features and availability vary by state. Restrictions and limitations may apply.

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