Question 1

What are annuities, and why are they popular with those nearing retirement?

Accepted Answer

An annuity is a contract between you and your insurance provider that requires them to release payments to you in the future. Most individuals purchase an annuity in preparation for retirement because it offers several benefits. These include earning tax-deferred and providing regular payment for a specific period (which could be the remainder of your life if you choose that option). Besides that, you can assign a beneficiary for your annuity so they can receive a death benefit should you pass away before your annuity is paid out to you in full.

Question 2

What are the different types of annuities available?

Accepted Answer

Annuities come in three main varieties — fixed, variable and indexed.

Fixed annuities earn at a constant rate for a specific amount of time. That prevents these annuities from being affected by market conditions. Fixed annuities are typically best suited for risk-averse individuals.

Variable annuities may result in higher gains, especially if the market does well. They also allow you to invest your funds in different options, resulting in a diversified portfolio. However, a dip in the market may lead to losses.

Indexed annuities are similar to variable annuities. However, your gains depend on a stock market index. Although insurers don't invest your money in the index, they use it (and its growth) to calculate your earnings.

Question 3

Can you customize your annuity contract?

Accepted Answer

Yes — that's one key benefit of investing in annuities. You can set them up to fit your needs.

For example, you can choose the type of annuity that suits your investment experience level and risk aversion. Another customizable area is your payout — you can receive payments immediately (one year within your purchase date) or deferred.

Payouts can also be made in one large sum or through a series of payments. If you choose the latter, you can set up your contract so these last throughout the remainder of your life or only within a specific period.

Question 4

Are there risks associated with purchasing annuities?

Accepted Answer

Despite the numerous benefits annuities bring, you must also consider the drawbacks you may encounter. These include illiquidity (making withdrawals before your annuitization phase may result in a surrender charge), numerous fees and potential losses (in the case of variable and indexed annuities).

Question 5

What is the tax treatment for annuities?

Accepted Answer

During the accumulation phase, your money grows on a tax-deferred basis. However, your payouts are subject to the regular income tax rate.

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