Using Annuities To Plan For Retirement An annuity, also called a long-term retirement savings contract, is another way to build your retirement savings through tax-free earnings. Annuities are contracts sold by insurance companies that guarantee a specific payment amount for some time in the future. Their limited flexibility makes annuities best suited for those who wish to have a consistent income in retirement and do not need access to the funds until at least age 59½.

Unlike an employer-sponsored pension plan or an Individual Retirement Account (IRA), the contributions put into an annuity are not given any tax break, but the earnings are still tax-free. Because the contributions are made with after-tax dollars, there is also no limit on the amount that can be deposited each year.

There are two distinct stages of an annuity: accumulation and payout. The accumulation phase is when the funds for the annuity are deposited. This can be done in one lump sum purchase (a single-premium annuity) or through recurring deposits over time. During this time, and up until payouts begin, any earnings on the annuity are tax-free.

The conditions necessary to trigger the payout phase will be spelled out in the individual annuity contract. Usually, payouts begin upon the beneficiary's retirement. The portion of any payout that is allocated to earnings is taxed in the year it is withdrawn. The remaining portion of the payout is the return of principal and is not taxed.

The amount of the monthly payments depends on the type of annuity purchased. Fixed annuities provide a set monthly payment with no risk of loss. While this can be a good option for those who will need a guaranteed income amount in retirement, the overall gain on the account may be far less than that of a well-managed stock portfolio. Variable annuities allow the investor to include stocks, mutual funds, and other securities in their annuity's portfolio. As with any non-guaranteed investment, there is a greater possibility of reward with a variable annuity, but there is also an increased risk of loss.

Equity-indexed annuities are a combination of fixed and variable annuities. There is usually a portion of the annuity that pays interest at a fixed rate, along with a portion of the annuity portfolio that is held in securities that may increase or decrease in value.

Annuities should not usually be used as one's only retirement savings account, but they can be used effectively to add to other types of retirement plans or investments. There is no limit on annual contributions, adding another option for those who have already maxed out their 401(k) or IRA contributions for the year. The fixed payout of an annuity can offer the peace of mind of a guaranteed, risk-free income throughout retirement.