Present-day annuities have been around for a few decades. However, the concept of an income stream paying out into retirement dates all the way back to the Roman Empire, when soldiers received annuities as compensation for military service.
During the Middle Ages, feudal kings turned to annuities to cover the cost of wars.
Annuities crossed the Atlantic to America in the mid-1700s when they were used as a retirement pool for church pastors in Pennsylvania. These were funded by contributions from the congregation and church leaders.
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Some of our Founding Fathers even resorted to annuities. Famously, Benjamin Franklin gave the cities of Boston and Philadelphia an annuity in his will. Franklin’s Boston annuity continued to pay out until the early 1990s, when the city opted to stop receiving payments and instead took a final lump-sum distribution of the remaining balance.
Although they still maintain the basic payment structure idea found in ancient annuities, modern-day versions aren’t funded by military rulers, peasants, or parishioners. And lords, kings, or other heads of state do not oversee them.
So who is creating and managing annuities today?
In the simplest of terms, annuities are financial agreements between an insurance company and a consumer. And that’s where a lot of the confusion sets in.
Because it’s a financial agreement, many people assume that the U.S. Securities and Exchange Commission or another financial body would primarily oversee annuities. But, in fact, this contract with an insurance company is primarily overseen by the insurance departments of each state.
In addition to issuing products like home, life, or car insurance, the insurance industry also issues annuities, an insurance contract that incorporates retirement savings. At its most basic interpretation, the insurance company accepts your payment, and then pays you an income stream starting immediately or in the future.
If you choose to be paid for the rest of your life, the insurance company assumes the risk that you may live longer than expected. It’s a risk insurance companies are comfortable with because they have a large pool of annuitants and because their actuaries use mortality tables to determine the appropriate income stream payments.
In essence, you enter into a contract with an insurance company to safe guard your money for a specified time frame, and in return, it provides you with a policy that spells out all the benefits due to you. Much like mutual funds that pool money from investors to be invested in things like stocks, bonds, and exchange-traded funds, insurance companies manage the money consumers put in an annuity in a way that aims to bolster the company’s bottom line. At the same time, while the owner of the annuity would not directly participate in the insurance companies’ investments, they may provide the consumer an attractive return.
There are some key differences between annuities and other investment options that make them advantageous to have in your retirement toolbox:
- Stability: The last several working years and the first few retirement years are crucial in retirement planning. While substantial market losses near retirement can devastate a nest egg with little to no time left to recover, an income annuity can guarantee a fixed payout regardless of whether the market is up or down.
- No contribution limits: Unlike other retirement vehicles like 401(k)s and IRAs, annuities aren’t hampered by contribution limits. There is a minimum premium, typically $1,000, but annuities allow you to sock away as much or as little as you like, as long as you meet that minimum.
- Tax deferral: Annuities also offer the tax benefit of your interest earnings being tax-deferred until they are paid back to you. This is important because taxes can take almost half your income on bonds and CDs. And when you do receive payouts later, you may find yourself in a lower tax bracket, lowering your tax liability. As a result of the tax benefits, there may be tax penalties for early withdrawals taken prior to age 59 1/2. You should consult your tax professional regarding your own personal situation.
- Some liquidity: One common misconception surrounding annuities is that they have no liquidity. But there are many liquidity features available, and if liquidity is a high priority, you can select a contract offering the liquidity features suitable for your needs. For instance, most annuities have a penalty-free withdrawal provision, typically set at 10 percent a year, allowing the owner to withdraw up to 10 percent of the premium — the money you put into the annuity — annually. Other liquidity options are also commonly available.
- Annuity guarantees: There are risks to be considered, however. Annuities aren’t guaranteed by the federal government like a bank-offered insured savings account or certificate of deposit. Instead, the guarantees made by the company issuing the annuity are backed by the financial strength and claims-paying ability of the insurance company — so if the firm folds, your income could be at risk.
Measuring the health of the insurance company you’re considering is important when selecting an annuity. Rating agencies like Moody’s Investors Service (Moodys.com
), Standard and Poor’s Financial Services (StandardandPoors.com
), Fitch Ratings (FitchRatings.com
) or A.M. Best Company (AMBest.com
) offer a snapshot of a company’s financial health to help you weigh the risk. Just keep in mind that those ratings are only valid on the day you check them and that you can’t predict a company’s financial health or solvency 5, 10, or 20 years from now.
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So don't overlook the financial strength of the company; it is just as important as the features of the annuity contract. At Crown Atlantic we only select annuity providers who are well rated by industry rating agencies. It’s important you have the safest retirement possible.
You can find out more about how to Increase your retirement income by up to 30 percent in Crown Atlantic's new report " The Annuity Primer: Get Guaranteed Income for Life." Go online to CrownAtlantic.com/Protect or call today 855-221-6246.
Joe Stark is the CEO of Crown Atlantic Insurance, LLC in Boca Raton, Fla. Stark is an insurance industry veteran with more than 25 years of experience. For more of his reports, Go Here Now.
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