What is an Annuity?

Annuities are a financial tool of varying popularity designed to help individuals plan for their future by providing a stream of income immediately (immediate annuity) or in the future (deferred annuity). The mechanics of your typical deferred annuity involve two distinct phases: the accumulation phase and the distribution phase. An immediate annuity just skips the accumulation phase and starts distributions.

During the accumulation phase, the policyholder makes one or more payments to the insurance company. The funds grow tax-deferred, meaning that any interest or gain earned within the annuity is not subject to income tax until withdrawals begin. This allows for potential compounding over time, contributing to the growth of the annuity’s value.

The distribution phase begins when the policyholder decides to start receiving payments. The annuity holder can choose between various distribution options, including receiving a fixed income for a set number of years or opting for a lifetime income stream with or without inflation adjustments.

There are pros and cons to annuities. On one hand, annuities allow for another avenue of tax-deferred growth during the accumulation phase. They can provide a reliable source of income during retirement. From an investment perspective, annuities are quite conservative and often come with a guaranteed minimum interest rate, protecting the principal from market downturns. This feature provides a level of security for conservative investors.

On the other hand, annuities can be difficult to get out of. They usually have high surrender charges, which are fees imposed if the annuity holder withdraws more than a specified amount within a certain period which limits liquidity. Additionally, annuity contracts can be complex, and fees associated with deferred annuities, such as administrative fees and mortality and expense charges, may impact overall returns. Finally, the fixed nature of some annuities might expose annuitants to inflation risk. If the annuity’s returns do not keep pace with inflation, the purchasing power of the income may decrease over time.

Before investing in a deferred annuity, individuals should carefully consider their financial goals, risk tolerance, and the specific terms of the annuity contract. Consulting with a Francis LLC financial planner can help in navigating the complexities of deferred annuities and making decisions aligned with individual needs and circumstances.

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