An annuity is a contract between an insurance company and an individual. The contract can be designed in many different ways to suit the person’s needs. Typically a person contributes a lump sum of money or multiple ongoing contributions of money in exchange for either: (1) a rate of return at a future date or (2) a series of income payments beginning at a future date. There are too many types of annuities to try to list in this post, but put simply: because of their tax structure, annuities are usually used for saving for retirement or providing income during retirement.
Why is an annuity primarily used for retirement savings? The reason is funds in an annuity grow on a tax deferred basis which can be extremely favorable. On the flip-side, since the IRS allows funds in an annuity to grow tax deferred, a 10% tax penalty is applied to the gains1 if the funds are removed before age 59½ . For that reason, Montana Life Group views annuities as an insurance product designed to help with retirement.
Why do people buy annuities? Because some annuities have lifetime income features. While the benefits of tax deferred growth are extremely attractive, many Americans buy annuities for the income stream they can provide in retirement. Decades ago a worker could depend on their company pension to provide monthly cash flow during retirement, similar to Social Security. In recent times pensions are less common as companies have replaced them with 401K plans. Many retirees prefer the concept of monthly income for a lifetime rather than access to a lump sum of cash, so they rollover their 401K funds or other savings into an annuity.
Some agencies which offer annuities tout them as investments that can yield above average gains and attractive interest rate bonuses. At Montana Life Group we do not view annuities as an investment with the potential for huge gains. Instead we view annuities as insurance products that contractually provide the security of income in retirement or conservative growth of retirement funds.
- This example applies to non-qualified funds. If qualified funds (IRA or 401K) are used in an annuity and removed before age 59.5 a 10% penalty can be applied to the entire amount.
See my screen