With continuing advances in medical technology, the average lifespan in America has been increasing for more than a century. It’s now commonplace to see someone live well into their eighties and beyond, which means living more years in retirement. While living a long, healthy life is good, it brings the increased responsibility of making sure that we don’t outlive our assets. In other words, you want your retirement income to last as long as you do.
An annuity (a contract between an annuitant and an annuity company) is a unique long-term savings/retirement income product that will not only help to accumulate wealth, but also to maintain wealth once it’s acquired. Annuities are classified into one of two categories: qualified or non-qualified.
QUALIFIED
Qualified annuities are part of a retirement savings plan, such as an Individual Retirement Account (IRA) or a Roth IRA, which are funded with pre-tax dollars (money that has been contributed before income taxes are applied).
NON-QUALIFIED
Non-qualified annuities are funded with post-tax dollars (money that has already been taxed) outside of a retirement plan, but still offer the benefit of tax-deferral.
Contribution limits and ability for tax-deferral are what makes this product unique when compared to other savings vehicles like 401(k)s, Certificates of Deposit (CDs), and Mutual Funds. While many investments are taxed each year, annuities are not taxable until the money is actually withdrawn for use. Also, unlike 401(k)s and conventional IRAs, there is no limit to the amount of money that can be invested in an annuity and the minimum withdrawal requirements for annuities are much more liberal than they are for most other products.
There are generally four types of annuities:
- Flexible Premium Deferred Annuity (FPDA)
- Single Premium Deferred Annuity (SPDA)
- Single Premium Immediate Annuity (SPIA)
- Equity-Indexed Annuity (EIA)
Flexible Premium Deferred Annuity (FPDA)
A flexible premium deferred annuity is designed to be funded with the flexibility of making contributions as frequently or infrequently as the annuitant desires. Also, all contributions made into a flexible premium deferred annuity will grow with interest until such time that the annuitant begins making withdrawals from it.
Single Premium Deferred Annuity (SPDA)
Just like a flexible premium deferred annuity, a single premium deferred annuity will grow with interest until such time that the annuitant begins making withdrawals from it. However, instead of being funded with a series of contributions, a SPDA is funded with a lump sum contribution, which often comes from rollovers, maturing Certificates of Deposit (CDs), or the sale of an appreciated asset.
Single Premium Immediate Annuity (SPIA)
A single premium immediate annuity is funded from a lump sum contribution like a SPDA is, but instead of deferring withdrawals to a later date, this type of annuity begins paying a monthly income immediately after the contribution is made.
Equity-Indexed Annuity (EIA)
An equity-indexed annuity is a special type of contract between an annuitant and an annuity company. An EIA is different from other annuities because of the way it credits earned interest to the annuity’s value. Other annuities only credit interest calculated at a rate set within the contract. EIAs credit interest using a formula based on changes in the index to which the annuity is linked, usually the S&P 500, which could allow for much greater returns. Like other types of annuities, an Equity-Indexed Annuity guarantees a minimum interest rate, even if the index rate is lower than the amount promised, which would explain why EIAs have become so popular, especially amongst those looking to accumulate wealth.