As members of a modern society that continues to live longer than ever before, retirees could spend more years in retirement than they ever imagined. In fact, two-thirds of all the men and women who have ever lived past age 65 – in the entire history of the world – are alive today, according to the Journal of Financial Planning.
In previous generations, people worried most about dying prematurely and leaving their families destitute. In this day and age, however, individuals must also be concerned about outliving their assets.
Purchasing a fixed annuity that can later be converted to a lifetime income stream may help offset the risk of depleting other types of retirement savings. Here’s a look at how this two-phase insurance product works as a retirement planning tool.
Accumulation Phase
You purchase a fixed annuity contract, make payments over a period of time or in a lump sum, and earn interest on the balance. A guaranteed rate of return is fixed for a specific term, regardless of economic or market conditions. Interest is tax deferred until withdrawals are made. The guarantees of fixed-annuity contracts are contingent on the claims-paying ability of the issuing company.
Annuitization Phase
When the contract is converted to produce an income stream, you and/or your spouse will receive fixed payments for a certain term, such as 10 or 15 years, or for life. Payout amounts are determined by the value of the account, the age and sex of the annuitants, or the length of the contract. The interest portion of annuity withdrawals is taxed as ordinary income. If the contract is surrendered prior to age 59½, it may be subject to a 10 percent federal income tax penalty. Surrender charges may also apply during the contract’s early years.
Think of an annuity as life insurance in reverse. You trade a portion of your savings up front for the security of a future monthly income – regardless of how long you may eventually live in retirement.