Annuities: turn retirement savings into income, with clear rules
An annuity is a contract with an insurance company. Some people use it to receive income in retirement or to protect part of their savings from market drops. It is not for everyone, and it has costs and limits worth knowing.
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Fixed annuity
The insurer sets an interest rate for a period, under the contract.
Indexed annuity
The interest credit is calculated from an index, with a cap, participation rate or spread, and a contractual floor (commonly 0%).
Income options
You can turn the contract value into periodic payments, even for life, through the contract's income option or an optional benefit that may have a cost.
What is guaranteed and what is not
An annuity's guarantees are defined in writing in the contract and depend on the claims-paying ability of the insurer that issues it. It helps to separate what is guaranteed from what is not:
Guaranteed by the contract
- The floor (commonly 0%) on the index-linked interest credit: a drop in the index does not by itself produce a negative credit.
- Lifetime income payments, if you choose that option, under the terms of the contract or benefit.
Not guaranteed
- The index performance and the credit you will receive.
- Caps, participation rates, spreads and current rates, which the insurer can change under the contract.
- The contract value: charges, withdrawals and the cost of optional benefits can reduce it.
What it can offer
- Growth potential tied to an index, with a contractual floor on the interest credit.
- The possibility of choosing lifetime income defined by the contract.
- Interest grows tax-deferred until you withdraw it.
- You can name beneficiaries.
What you should review
- Surrender charges for several years and limits on annual free withdrawals.
- Optional benefits, such as lifetime income, can have a cost.
- Withdrawals are taxed as ordinary income on the gains and, before age 59½, an additional 10% penalty may apply.
- Your money is committed: you have less liquidity than in a bank account.
- Fixed payments can lose purchasing power to inflation.
- State guaranty association protection has limits.
You do not have to move it, but it helps to know your options
You can usually leave it in the plan, move it to your new employer's plan, roll it over to an IRA, or cash it out. Each option has different costs, available investments, rules and taxes. A direct rollover, from institution to institution, generally does not create taxes at the time of the transfer; receiving a check in your name can bring withholding and taxes. Talk to a tax professional about your case.
Before recommending any change, we review your goals and situation and compare with your other options, including leaving your money where it is.
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Questions about annuities
What happens to an indexed annuity if the market falls?
The index-linked interest credit has a contractual floor, commonly 0%, so a drop in the index does not by itself produce a negative credit. That applies only to the interest credit: charges, withdrawals and the cost of optional benefits can reduce the contract value. The guarantee depends on the terms of the contract and the insurer's claims-paying ability.
Does it guarantee lifetime income?
If you choose a contract's lifetime income option, the payments are defined by the terms of that contract or benefit and depend on the insurer's claims-paying ability. The amount depends on your age, the contract value, the option chosen and the cost of the benefit.
Can I take my money out whenever I want?
Many annuities allow limited withdrawals each year without a charge. Larger withdrawals during the surrender period can have surrender charges and create taxes.
Is an annuity an investment?
No. It is a contract with an insurance company, not an investment account in the market.
Do I have to move my 401(k) to have an annuity?
No. Leaving the 401(k) where it is is also an option. Some people use money from other sources, and the decision depends on your goals, costs and taxes.
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