Annuities, what are they? Is this a good retirement option for you? Annuities can be a retirement tool used in addition to traditional retirement savings such as 401(k)s or IRA’S

. Below is a review of the basics and the upsides/downsides of using annuities in addition to regular retirement savings tools.

Basics of Annuities

There are three different ways to use annuities, you can increase your savings, protect what you’ve saved, or create a stream of income. Annuities typically fall into two categories: deferred and income.

Deferred Annuities

Deferred annuities can be a good way to increase your retirement savings once you have reached your maximum tax-deferred contribution to either your 401(k) or IRA

. Just like your IRA or 401(k), your contributions will compound over time, which means greater growth of your money. Whereas other taxable  retirement accounts will yield less money.

This type of annuity has two main phases, the savings and planning phase in which you invest money into the account, and the income phase in which the plan is converted into an annuity and payments are received. This type of annuity can either be fixed or variable.

  • Fixed

     is known for its predictability and consistency, this is the most popular type of annuity among retirees, simply due to the fact that you will have a fixed rate of income you can rely on once you reach your retirement years.

  • Whereas a variable

     annuity has no guaranteed returns, this is due to the fact that ones investments are in multiple accounts comprised of stocks, bonds and money market instruments. This type of annuity is much less popular due its lack of guaranteed return.

Upside

The IRS has no contribution limits when it comes to deferred annuities, meaning you can contribute as much as you like. In addition you can use these savings as consistent stream of income in your retirement years. Earnings on a deferred annuity account are taxed only upon withdrawal, providing this type of annuity with a tax benefit. Deferred annuities also provide a death benefit, so your chosen beneficiary of the annuity is guaranteed the principal amount as well as the compounded interest. Giving you peace of mind.

Downside

However withdrawals from an annuity are susceptible to income tax, furthermore if taken prior to age 59, you could be subject to  a 10% IRS penalty tax. Annuities are also subject to yearly fees that are not found in mutual funds, this of course will also affect you end return.

Income Annuities

On the other side of annuities, there is something called income annuities

, this type of annuity may be smart for investors in or near retirement because they offer income for a set amount of time.

Immediate variable income annuities offer an immediate income stream with potential  growth, this is designed to help keep up with inflation. This type of income is guaranteed, however the amount of each payment is based on the annuity’s base investments.

Immediate fixed income annuities offer predictable payment for life, or for a specific amount of time. This type of annuity can not be affected by market, unlike its variable counterpart. This type of saving is typically attractive to the conservative investor.

Deferred income annuities are fixed income annuities (see above), however have a deferred payout, which may result in a higher payout than the investment.

Is an Annuity right for you?

An annuity may be a great option if you are worried that your current retirement savings plan may come up short. In terms of which annuity is right for you, it all boils down to how much risk you’d like to take with your investments.