How Annuities Can Be Part of Your Investment Plan
Annuities might seem complicated, but they are actually a simple and powerful tool. In exchange for a sum of money, you receive a guaranteed income payment each month.
Why trust The Military Wallet? We’re a veteran-founded resource that has helped millions make strong financial decisions.
Advertiser Disclosure: The Military Wallet and Three Creeks Media, LLC, its parent and affiliate companies, may receive compensation through advertising placements on The Military Wallet. For any rankings or lists on this site, The Military Wallet may receive compensation from the companies being ranked; however, this compensation does not affect how, where, and in what order products and companies appear in the rankings and lists. If a ranking or list has a company noted to be a “partner,” the indicated company is a corporate affiliate of The Military Wallet. No tables, rankings, or lists are fully comprehensive and do not include all companies or available products.
The Military Wallet and Three Creeks Media have partnered with CardRatings for our coverage of credit card products. The Military Wallet and CardRatings may receive a commission from card issuers. You can read more about our card rating methodology here.
Opinions, reviews, analyses & recommendations are the author’s alone and have not been reviewed, endorsed, or approved by any of these entities. For more information, please see our Advertising Policy.
American Express is an advertiser on The Military Wallet. Terms Apply to American Express benefits and offers.
- Annuities come in two investment models, fixed and variable. Fixed annuities offer guaranteed, stable growth while variable annuities carry more risk but the potential for higher returns.
- How you receive income from an annuity, immediately or deferred, determines how it fits into your broader retirement plan.
- For military retirees already receiving pension income, annuity distributions are also taxable at the federal level, making tax planning an essential step before purchasing an annuity.
When it comes to planning for your retirement, annuities can be one of the most powerful tools in your arsenal. While annuities can seem complicated, they are surprisingly simple. In this article, we will cover all the essential basics that you need to know.
What Is an Annuity and How Does It Work?
When you purchase a life insurance policy, your premium payments are pooled with others to fund the benefits that the insurer will pay out to all beneficiaries.
With an annuity, the money you pay earns interest and is used to generate a guaranteed income payment. Annuities really are that simple: you pay a certain amount of money and you receive back a portion of that premium deposit plus interest each month for a fixed period or the lifetime of a designated individual.
There are many different types of annuities, but each has just three basic factors: how you fund the annuity, how the investment is managed, and how you receive income payments.
How to Fund an Annuity
There are two different payment models for annuities: a single premium or a more flexible installment premium.
A single premium annuity is funded through one lump-sum payment. Often this lump sum comes from liquidating other assets such as a TSP, IRA, home equity, or investment portfolio. This can be a particularly useful option for military retirees who receive a lump sum from separation pay or other benefits.
An installment premium annuity is funded over time through either scheduled or unscheduled premium contributions and is a great option if you are still serving but want to diversify your retirement assets beyond your TSP and military pension.
Deferred annuities are often funded in an installment premium model but could be used to safely grow a lump sum investment as well. Immediate annuities are always funded with a lump-sum deposit.
How Annuity Investments Are Managed
While annuities are not investments in the traditional sense, your premium deposits will be invested by the insurer in order to increase the value of the annuity. There are two models for investing the principal.
The first model is a fixed annuity. In a fixed annuity, the principal is invested primarily in bonds and other fixed return investments. This allows for a set interest rate and guarantees that the principal will not lose value if contract terms are completed. While fixed annuities may grow more slowly than other investment models, they provide valuable stability and peace of mind, particularly appealing for military retirees who already have the variable nature of markets affecting other parts of their portfolio.
The second model is a variable annuity, which involves greater risk but the potential for a higher reward. With a variable annuity, you choose from a set of options where your funds are invested. If the investments perform well, variable annuities can grow more quickly than a fixed annuity; however, there is also a risk that the principal could lose value. Variable annuities often have larger fee structures than many lower-risk fixed options. Common fees include mortality and expense risk charges, administrative fees, and investment management fees, which can significantly reduce your overall return over time. Always review the fee structure carefully before committing to a variable annuity.
One important consideration for both fixed and variable annuities is the surrender charge, a fee charged if you withdraw funds before the end of a specified period, typically ranging from five to ten years. For military members who may face unexpected financial needs or PCS moves, it is important to understand your annuity’s surrender period and any associated penalties before committing. Some annuities offer surrender-free withdrawal provisions that allow you to access a portion of your funds, typically up to 10% annually, without incurring a penalty.
How Annuity Income Payments Work
How you receive the guaranteed income is the final factor that determines the type of annuity that may work best for you, immediate or deferred.
Immediate annuities will begin distributing income payments within 1 to 13 months of purchase. Immediate annuities are often funded with a single premium contribution and are typically used as a tool to spread out income taxation or reduce the risk of outliving assets.
For example, a military retiree might roll all or a portion of their traditional TSP savings into a qualified immediate annuity at retirement to ensure that the savings last for the entire duration of retirement. In that way, immediate annuities are similar to a military pension’s defined benefit or Social Security income payments, providing a reliable, predictable monthly income stream.
Deferred annuities grow the principal deposit in a tax-advantaged way until you decide to either cash out in lump sum or initiate an annuitized income distribution. Income payments are generally greater the longer you wait to distribute, due to a longer interest accumulation period. That means that you can increase your payments by initiating distribution later, or opt to start receiving payments earlier in exchange for a lower monthly amount.
If you don’t have a need for more taxable income today, deferral is most likely the right choice for you. If more favorable tax treatment is desired, annuitizing your accumulation amount into a guaranteed income payment for a fixed period or lifetime income would result in a portion of each income payment to be returned tax-free.
For military retirees already receiving pension income, it it worth considering the tax implications of adding annuity income on top of an existing pension. Both sources of income are taxable at the federal level, which could push you into a higher tax bracket. Consulting with a fee-only financial planner familiar with military benefits can help you determine the most tax-efficient way to structure your annuity distributions alongside your pension and TSP withdrawals.
If you are still deciding whether an annuity is the right fit for your retirement plan, see our guide on whether an annuity is right for you.
