An annuity is an investment that allows you to make a one-time payment or long-term series of contributions to a savings account that pays you a guaranteed income for a set amount of time. You can use various investment vehicles inside your annuity, depending on the time you start and the car you choose. It’s possible to use higher-risk investment funds within your annuity. If you’re closer to retirement, you probably want to stick with a lower-risk investment tool.
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Depending on when you plan to retire, how long you’re going to work, and what other investments you have in the works. You can purchase a deferred annuity that will pay you a guaranteed income later in life. In this way, it’s similar to social security. If you take your social security payments as soon as you can get them, you’ll receive more payments but a smaller check each month. A deferred annuity can provide you with more considerable amounts later in life when your earning capacity reduces.
One Time Annuity
One-time annuity purchases can protect your assets in the event of a severe medical crisis. For example, if you and your spouse jointly own retirement funds and one of you is suddenly in need of long-term care. Medicaid requirements in your state may force you and your spouse to spend down half of your retirement income before getting financial help from Medicaid.
Before buying such an annuity, be sure to talk to an attorney to protect your home, retirement funds, and other assets. Be aware that these annuities, while saving your cash, can be overly restrictive and tie up your monies in the event of the death of either spouse. With the right help and planning, these Single Premium Immediate Annuities, or SPIAs, can protect your joint assets.
Annuity Within the 401(k)
Depending on your current retirement vehicle, there may be an annuity within your 401(k) structure that you can use to rollover your 401(k) funds, protecting you from the tax burden of withdrawing all the money at once. You can also buy and populate an annuity with your 401(k) funds at the time of retirement.
Annuity Outside the 401(k)
If you’ve maxed out your 401(k) and want to put away more of your income in a tax-deferred vehicle, buying an annuity for these purposes can:
- Reduce your current income tax burden
- Allow you to grow more funds tax-deferred.
- I look forward to a guaranteed income in the future.
To purchase your annuity, you must put in the time to make a wise purchase with a reputable company. Banks or other financial institutions covered by the FDIC protect annuities. Annuities are bought from, managed by, and owned by insurance companies. You want your investment dollars to be managed by an organization with a strong reputation. Deep financial reserves if you’re going to count on this income when you’re past your earning years.
You can roll some or all of your 401(k) funds into an annuity that will turn them into a fixed income for your future. You can also make plans for these funds in the event of your death and direct them to your surviving spouse or other beneficiaries. An annuity rollover of a 401(k) can get costly.
For example, you may face:
- High fees from the company selling you the annuity
- High brokerage fees to the person setting up the annuity contract
- A 20% balance penalty from the IRS if the annuity takes too long to set up
If you plan on rolling any portion of your 401(k) into a pension, do your best to set it up before you retire. Be aware that your 401(k) administrator must maintain your investment plan if you have more than $5,000 in there, so you don’t have to rush it into an annuity, an IRA, or a distribution.
The action you must guard against is taking a lump-sum distribution from your 401(k) and buying an annuity with it. Once you withdraw a lump sum, you will have triggered the income tax payment requirement. Either roll the funds or leave them in your 401(k).
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Annuities as Part of Your Portfolio
Your tax-deferred retirement savings can sit in your account and make money for several years after you retire. Still, you must take Required Minimum Distributions, or RMDs, at around the age of 70. Be aware that this age limit has changed repeatedly, so stay on top of these regulations to avoid the RMD penalty as it is severe.
To avoid the RMD penalty, you can
- Purchase an annuity with part of the money
- Roll the funds into an IRA
- Use the IRA funds to give to a qualified charity.
- Transfer the IRA funds into an educational or special needs trust
Depending on how you set up your annuity and whether you need to access Medicaid, you can direct your annuity to the recipient of your choice if you die before the annuity pays out. You can also buy an annuity that will pay out until you die, no matter how much money you put into it.
Suppose you have the funds available and want guaranteed income. In that case, you could conceivably purchase an annuity that provides you with deferred payment, such as a payout that starts when you turn 75. Your spouse could have an annuity that provides guaranteed income from your retirement date. This combination would not only solidify your income. You would have the security of knowing that your most physically challenging years would be made easier with guaranteed income.
Make your decisions regarding an annuity purchase early. A rushed financial decision is seldom the best option, particularly if you’re facing a health crisis. Talk with your financial planning expert about making sure you avoid RMD and rollover penalties. Find an annuity with low fees that will pay out throughout your lifetime. Determine whether your state requires financial vehicles that will protect you against Medicaid spend-down requirements. Go into these decisions with as much information as possible to avoid unpleasant surprises.