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What Types of Investments Guarantee Payments in Retirement?
Whether you’re just starting to look towards a retirement that’s 40 years away or you’re getting close to pulling the plug on your working life, you can never plan too much for retirement. Some of the most common ways of investing for retirement involve mutual funds or stocks. But those aren’t truly ways to guarantee that you’ll have a steady income during your non-working years.
If the market goes down, you may not want to continue pulling money out of those retirement funds to survive since you might not recoup what you withdraw. So considering a way to invest that will guarantee you payments during retirement is a smart way to prepare for the future. No matter what the market does or how other people’s retirement funds are performing, having a steady stream of income during your retirement will give you peace of mind.
There are a few different ways that you can invest for the future so that you can have guaranteed payments during retirement. In this article, you’ll learn about the three main options: an annuity, a pension, and social security. The best option for you will depend on your own circumstances and opportunities, but let’s dive a little deeper into each of these options.
What is an Annuity?
The easiest way to think about an annuity is that it is retirement insurance. While there may be other ways to interpret them, that’s basically what they are. With an annuity, you’re paying into a fund that will then pay you steady payments once the annuitization period begins. Of course, they’re not that simple, and there are some things to keep in mind while you’re considering paying into an annuity.
Annuities can be designed to a wide variety of factors that depend on each circumstance, so there is no right or wrong way to structure an annuity. They can be structured based on how long you want them to pay out, how much you want the payments to be when you’d like the payments to begin, and other factors. When you’re paying into an annuity, you want to be sure that the benefits you’re receiving are sufficient for you and your loved ones.
What Should I Consider When Shopping for an Annuity?
One of the main things to consider when you’re looking into annuities is how long you want the payments to continue. They can be structured so that the financial institution pays installments until you die or they can be set up to pay out for a specified number of years. They can also be designed to include spousal benefits that continue to pay to your spouse if you were to die first.
Other than the length of payments, you’ll want to decide between a fixed or a variable annuity. These terms refer to the payments that you receive, being either a fixed amount or a variable payment. Fixed annuities will pay out an agreed-upon amount consistently for the life of the annuity. Variable annuities will provide varying payments depending on how the underlying investments are doing.
Another major aspect of annuities is to decide on when you want the guaranteed income to start. Based on that, you can decide to purchase an immediate annuity or a deferred annuity. With an immediate annuity, the payments start right away when you purchase it with a lump sum. This is perfect for anyone looking to retire soon or who is already in retirement.
With a deferred annuity, your account value grows over time, and after a certain amount of time — typically 10 years — you’re able to start receiving your steady payments.
Are Annuities Taxed Like Income?
The tax rules can be confusing when it comes to annuities. But how annuities are taxed is mostly dependent on what funds were used to purchase that annuity. If you’re familiar with traditional retirement accounts and their Roth counterparts, then you’ll have a pretty good idea of how annuities are taxed in general. If not, here’s a quick refresher.
Roth retirement accounts, either 401(k) or IRA, are accounts that have been funded with after-tax money. Meaning that you’ve already paid the taxes on that money and therefore anything you do or earn with it is also tax-free. With traditional (non-Roth) assets, you deduct those funds from your taxable income now, but then you pay the taxes later when the money is used.
So for annuities, if they’re purchased with Roth assets such as in a Roth IRA or any other after-tax money, then the annuity payments later in life might be entirely tax-free. If they’re purchased within a traditional tax-deferred account, then the annuity payments during retirement will be taxed like regular income.
Other factors can change how the annuity is taxed later in life, but those are specific to certain annuities. For example, immediate annuities can be taxed differently than deferred benefit annuities. And fixed annuities can be different from variable annuities. But the easiest way to think about taxes, in general, is to just understand which funds were used to buy into the annuity in the first place.
What is a Pension?
A pension is basically a type of annuity, but it’s one that is offered by your employer as a guaranteed retirement benefit. Pensions used to be the most common method of employer-sponsored retirement accounts, but 401(k)’s have long since taken over that mantle. But retiring with a pension can be a great way to ensure you have adequate income during retirement.
Pensions are largely still offered at government agencies of varying levels, with the federal government providing its workers with a steady pension that many would love to have. For this reason, people may often work for the government for at least some of their careers just to earn a pension of some sort for retirement.
How Does a Pension Work?
Like an annuity, pensions are paid out in monthly payments during your retirement years to help fund your retirement. These payments can be paid for for a certain number of years, be paid until you die, and also continue being paid to your spouse if something were to happen to you. In those ways, and with the ways that they are taxed, pensions are similar to annuities. More often than not, a pension will be taxed like regular income in retirement because of how they are funded through your and your employer’s contributions.
To earn a pension, you’ll need to work for an employer that offers one and pay into it over the years that you work there. In many cases, paying into the pension is automatic and cannot be opted out of, but you can often withdraw the lump sum of your contributions when you separate from that company. But before you take the lump sum, make sure you understand what you’re giving up in retirement later!
You also want to make sure that you understand the vesting schedule for your pension. The vesting schedule will tell you how many years you have to work for your pension to be fully vested, meaning you get the full amount. For government pensions, it’s also based on your years of service. So the longer you work for the government, the more your pension will be during retirement. Keep that in mind when you’re considering a job change.
Is My Pension Protected?
You may have heard horror stories about the company’s pension funds running out of money and leaving the recipients high and dry in retirement. If someone is counting on a pension for retirement and the fund runs out of money, they can be left holding the bag with nothing in it. That’s the worst-case scenario for anyone thinking about retirement.
Some pension funds are more secure than others, such as the government’s. But if you are looking at a different place of employment that offers a pension, it’s a good idea to see if it’s covered by the Pension Benefit Guaranty Corporation. This government-funded insurance program will basically guarantee some portion of the pension gets paid out to the recipients no matter what.
Should I Get a Job That Offers a Pension?
If you’re searching for a job or thinking about a job change, it’s never a bad idea to find something that offers a pension. Most places that offer a pension, such as the government, also offer additional employer-sponsored retirement plans. So while you’re working during your career, you can be investing in a retirement plan like a 401(k) — or Thrift Savings Plan for government workers — while simultaneously contributing to your future pension.
This can really set you up for success in the future when you go to retire. Having access to a nest egg within the typical retirement fund while also receiving guaranteed income from a pension is a great way to be prepared for your retirement.
Is Social Security Enough for Retirement?
Social Security is the government-sponsored retirement funding that is handled by the Social Security Administration. To be eligible for Social Security, you need to have contributed to the program for at least 10 years during your working years by paying into what’s common called the “Social Security tax”. In reality, you’re paying into the government’s Old-Age, Survivors, and Disability Insurance program (OASDI).
Social Security payments can start being claimed at age 62 if you opt for early retirement. If you do so, you’ll incur a permanent penalty on your monthly payments. You can also choose to wait until your full retirement age — 66 or 67 depending on your birthday — to get the full amount. But if you want to get the maximum amount possible, you can wait until you’re 70 years old before you start claiming Social Security benefits.
Although Social Security is a great addition to any retirement plan, it is not recommended that you rely only on Social Security to fund your retirement. Not only are the typical benefits less than you can achieve with other forms of retirement, but there are also no guarantees that Social Security will still be around when you reach retirement age. And if it is, the benefits offered could be even less.
So try to have other forms of retirement available to you other than just Social Security!
What Are Other Types of Investments For Retirement?
Annuities, pensions, and Social Security are great for retirement because they offer a guaranteed stream of income during your non-working years. But as you plan your retirement, keep in mind they are not the only way to get ready for your golden years.
Combining guaranteed income retirement plans with other types of investments can provide the best balance and afford you the best lifestyle in retirement. Other than fixed income retirements, the two most common ways to invest for the future are a 401(k) and an IRA (individual retirement account).
A 401(k) is an employer-sponsored retirement fund that enables workers to contribute some of their salaries to the account and maybe even get a bonus 401(k) match from their employer. An IRA is a tax-advantaged account that you can open on your own and contribute money to that will grow over the years and be there when you reach retirement age.
No one method of planning for retirement is better than the other, and having a little bit of each can help best prepare you for retirement financially. So consider adding an investment with guaranteed payments to your retirement plan and have the retirement of your dreams!
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