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Buying annuities: Weighing the pros & cons

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It can be tough to predict how long your retirement savings will need to last. Will you live to age 75? Or even past 100? Annuities can provide a guaranteed income stream in retirement that lasts the rest of your life and helps eliminate some financial stress about outliving your savings. When you know there's a reliable income to help supplement Social Security, a pension and other retirement money, it opens up possibilities—so you can focus on living the retirement you want with confidence.

As with any product, there are pros and cons of annuities. Understanding them can help you decide whether an annuity is a good retirement solution for you.

How annuities work: A quick review

An annuity is a contract between you and an insurance company that can provide guaranteed income in retirement. You can choose a guaranteed income stream for a set period of time or for the rest of your life. Annuities work by putting money into the contract, either through a lump-sum premium or through a series of premium payments. Those funds then have the potential of tax-deferred growth, which later can be turned into ongoing income payments. Simply put, annuities are designed to be both a savings vehicle and a source of retirement income.

There are two phases to an annuity: accumulation and payout.

Accumulation phase: Building your assets

When you purchase an annuity, you provide either a one-time or regular premium contributions. You can elect a date in the future when you'll start taking payouts. This period before you start taking payouts is referred to as the accumulation phase.

If you withdraw money from your annuity during the accumulation phase, there is typically a surrender charge period. This means your withdrawals may be subject to a surrender charge. This is because money is meant to stay and grow until you use it in retirement.

You'll have different options for how your money can potentially grow during the accumulation phase depending on the type of annuity you choose.

Payout phase: Taking retirement income payments

When you are ready to begin the payout phase, you may elect how you will take money out of the annuity. You may take ad hoc withdrawals, systematic withdrawals, or a settlement option (also known as annuitization). Depending on the settlement option you elect, payments will continue for a set period or for the rest of your life. A settlement option may or may not have an inheritable death benefit depending on the option you select

What are the types of annuities available?

Annuities come in a variety of types, each with varying options. As you weigh options, also think about when you want to start getting payments and what investment options you prefer. Here's an overview of two of the most common types of annuities:

Fixed annuities: The type with a guaranteed interest rate

A fixed annuity is an insurance product that offers a current rate and a guaranteed minimum interest rate, so your annuity’s value is not affected by market volatility. As with all annuities, earnings are tax-deferred until you start receiving payments

There are multiple types of fixed annuities to choose from:

  • Traditional fixed-rate annuities earn interest at a guaranteed minimum interest rate, or a current rate if higher. With a fixed interest rate, you know in advance how much your annuity will grow.
  • Multi-year guarantee annuities you lock in a rate for a set period of time, for example, three, five, seven, or nine years, somewhat similar to CDs. At the end of the period, you typically have these options: You can withdraw your funds, renew your annuity at then-current rates, choose an annuity payment option, or leave the money with the insurer, where it will earn interest at a renewable one-year rate set by the company.
  • Fixed indexed annuities pay rates based on the performance of a market index, such as the S&P 500, without actually putting your principal at risk in the market itself. If the index has positive returns, you may earn more interest (up to a cap, such as 7%) than you would with a traditional fixed-rate annuity.

Variable annuities: The type dependent on market performance

Variable annuities allow you to invest your money into select subaccounts dependent on market performance. The value of a variable annuity rises and falls over time depending on how the subaccounts perform. Higher gains can translate into higher payouts, and lower gains and losses tend to result in smaller payouts. A key factor to consider with variable annuities is that you can invest according to your risk tolerance, potentially resulting in greater long-term gains than other types of annuities.

You may choose to add a guaranteed lifetime withdrawal benefit rider for an additional fee to your variable annuity. These riders provide specified annual withdrawal amounts for life even if your annuity value is depleted. Guaranteed withdrawals may allow you to feel more confident about the future so you can focus on your goals in the present knowing you won't outlive your money.

The earnings from variable annuities are tax-deferred until you take payments. You can choose to receive payments immediately or later, and you may have options for death benefits if you pass before payouts start.

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What are the pros of annuities?

Like many other retirement income options, there are pros and cons of annuities. However, annuities have many upsides that may benefit your long-term financial plan. Here are some key ones to consider:

The option for lifetime guaranteed income

Perhaps the biggest advantage—and the key characteristic—of an annuity is its guaranteed payments throughout retirement. Outliving your money is a real concern for retirees. Thrivent's Retirement Readiness Survey found that 39% of retirees are worried their savings won't last through their lifetime. With any annuity, you can opt for lifetime income, which means you'll have money coming to you regularly no matter how long you live. Annuities can be a good option to help bridge the gap between Social Security and other retirement funds.

The potential for tax-deferred growth

Any earnings from your annuity grow tax-deferred, so you don't have to pay taxes on those gains until you start receiving payments. That can help the money in your annuity grow and compound without being reduced by tax payments.

They offer a death benefit with guarantees

If you die before you receive your lifetime income (or any payout option), annuities generally provide a death benefit that guarantees your beneficiaries never will receive less than the amount contributed to the contract, less any withdrawals or fees.

What are the cons of annuities?

Before deciding on any financial product, it's important to consider the potential drawbacks. Here's what to know about the disadvantages of annuities:

There are costs & potential penalties

Before purchasing an annuity, get a rundown of the potential fees you may need to pay during the life of the contract. Most annuities charge fees for annual maintenance and operations. If you take out funds early, you also may have to pay surrender charges and tax penalties.

They may not keep pace with inflation

During high inflationary periods, the cost of living can rise, and the growth of some annuities may not keep up with the inflation rate. Some types of annuities, like variable annuities, may be better equipped to keep up with inflation, as you can select from several types of variable subaccounts.

Is an annuity good investment?

For some investors, an annuity can be a good fit. It all depends on your long-term retirement goals, financial situation and investment strategy. An annuity also can provide another option for tax-deferred investment growth if you've maxed out your other retirement contributions.

One thing to consider, though, is the potential tax implications. Work with your tax professional to determine how to maximize your tax strategy with annuities, especially if withdrawals in retirement could bump you into a higher income tax bracket.

Get advice from a trusted professional

Before making any investment decisions, it's a good idea to discuss your situation, concerns and goals with a professional, who can help you determine if an annuity is the right fit for you. To learn more about annuities, connect with a local Thrivent financial advisor.

Annuities are intended to be long term, particularly for retirement. Guarantees are based on the financial strength and claims-paying ability of the insurance company/insurer.

Thrivent and its financial advisors and professionals do not provide legal, accounting or tax advice. Consult your attorney or tax professional.

Holding an annuity inside a tax-qualified plan does not provide any additional tax benefits. Withdrawals and surrenders will decrease the value of an annuity and subsequently the income received. Any withdrawals in excess of 10% may be subject to a surrender charge. The taxable portion of each annuity distribution is subject to income taxation. If a taxpayer is younger than 59½ at the time of distribution, a 10% federal tax penalty will apply to the taxable portion of the distribution unless a penalty-tax exception applies. Thrivent and its financial professionals do not provide legal, accounting or tax advice. Consult your attorney or tax professional.

Thrivent financial advisors and professionals have general knowledge of the Social Security tenets. For complete details on your situation, contact the Social Security Administration.

Investing involves risk, including the possible loss of principal. The prospectus and summary prospectuses of the variable annuity contract and underlying investment options contain information on investment objectives, risks, charges and expenses, which investors should read carefully and consider before investing.

Riders are optional and available for an additional cost.