Single Vs. Flexible Premium
Paying for an Annuity
There are two main ways to pay for an annuity. The way that you pay for your annuity will vary depending upon what your goals are and which type of annuity you select to try and meet those goals. These two payment methods are very different, but they are both there so that you can find what is best for you.
The first way to pay for an annuity is with a single premium. Single premium annuities are paid for in one lump sum. They can gather interest for as long as you want before you decide to annuitize them. Sometimes, there are exceptions that can be made. Lump sump annuities can either be immediate or deferred in their payout structure—which allows you to customize this choice to meet your needs even further.
Some insurance companies will allow you to put in more money for up to a year after the contract date and still consider the annuity to be a single premium. In these instances, if you want to put in more money after the one year date, you would need to start a new and separate policy. There are no limits as to how many annuities you can own. Some people use a portfolio of many annuities to help achieve their financial goals. In this instance, a single premium annuity can be helpful for adding diversification.
There are several situations where this type of annuity will be useful to you. If you have saved a larger sum of cash and want to start earning interest on it, buying an annuity all at once is a good way to get your money into an account that can earn a higher rate of return than a savings account will.
Also, because most other types of retirement accounts have age limits when it comes to distributions, lump sum annuities can be a good way to transfer assets without being penalized for not taking distributions. For example, if you own an IRA, tax laws in the United States require you to begin distributions before age 70 ½. If you do not begin distributions, there will be IRS penalties that you’ll have to pay. For most people, this age limit isn’t a problem, but for some it is. Transferring your IRA into an annuity will help you to avoid that mandatory distribution age and continue to grow your money until you need it.
Finally, when someone comes into a large sum of money, an annuity can be helpful. We’ve all heard those horror stories about lottery winners who have managed to spend millions of dollars in a year or two of winning and are now bankrupt. Placing money in an annuity can help to avoid this. It creates a forced savings since the money cannot be used without penalty until age 59 ½, and after it is annuitized, it creates a steady and reliable source of income month after month.
The other main type of annuity payment is the flexible premium. A flexible premium annuity will allow you to add more money throughout the life of the contract—at least up until the annuitization date. There are technically no restrictions on how much you may add per year, although some insurance companies might have a minimum deposit amount associated with their specific policies. It is important that you are aware of any premium restrictions that your company has in place. The most common way to invest with a flexible premium is to earmark a percentage of your paycheck to go directly into the annuity. This makes flexible premium annuities a good and automatic way to save money for your retirement years, much like an IRA or 401(k).
This is why most people use a flexible premium when they purchase an annuity. It makes sense to set aside a little bit every month so that we can have a greater amount to live off of when we retire. The younger you are, the more appealing this type of payment is. This way, our money that is being invested fluctuates with the market before it is invested—and after. It does a much better job of keeping up with inflation than a lump sum payment. Again, this is what most do already, but it really depends on which stage of life you are in.
You might already have an annuity. If you work for a state government or work in a public school, you are familiar with 403(b) plans, which are a type of variable annuity.
Which Payment is Best?
Really, the best way to pay for an annuity will be determined by your unique situation. Most people will benefit from a flexible premium rather than a single simply because it is easier to pay a little bit at a time for most people. However, you know your situation and circumstances better than anyone else. Working with a financial professional to guide you can be helpful if you are still unsure about which type of annuity and payment structure will be most beneficial for you.
Remember that an annuity is designed to help you. Rushing into a contract will not be as profitable as taking your time and doing your research so that you can select the best method of funding your retirement, helping to pay for a spouse’s retirement, or a multitude of other purposes. Hopefully, this brief guide has helped you to point yourself in the right direction.