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How do annuities work?

An annuity could be a valuable addition to your retirement plan. Here's how they work.

Couple sitting down looking reviewing information.

The Income You Can't Outlive

An annuity can be a great retirement tool. State Farm® Agent Ken Quach in Houston, Texas, has helped a lot of people with annuity planning, and he's here with some helpful info about how annuities work.

Keep in mind, the following information pertains to fixed annuities only. Variable annuities work differently and have more of an investment risk component.

Annuities 101

At its core, an annuity is a savings option for retirement. As Quach describes them, "An annuity provides a way for you to save money on a tax-deferred basis, and receive a steady income in retirement you can't outlive. It's a contract between the owner of the annuity and the company issuing it. You buy the annuity, and the company pays you interest on the money. At a certain age, you start taking the money out, and you could receive payments for as long as you live."

The Two Types

State Farm annuities are purchased with one single premium, and there are two main types:

  • Immediate Annuity - generates income immediately after purchase
  • Deferred Annuity - allows your investment to grow tax-deferred until you decide to start receiving income payments at a point in the future

Quach says that most people who purchase deferred annuities tend to be more risk-averse. "They want a low-risk savings vehicle prior to retirement that will be there for them no matter what. Most people who buy immediate annuities are close to, or are already retired and looking for a way to create a steady income stream right away."

The Two Phases

Annuities have two phases:

  • Accumulation Phase - when you're putting the money in
  • Annuitization Phase - when you start taking the money out

Accumulation Phase

Quach explains, "The accumulation phase is the period of time after you purchase your annuity and before you start receiving payments. During this phase, your investment will grow at a guaranteed minimum interest rate. This growth is tax-deferred for annuities purchased outside of a qualified retirement plan, like an IRA or 401(k)1."

Annuitization Phase

The annuitization phase is when you start receiving payments, typically at retirement. Quach talks about some of the different payout choices you have. "Annuity owners have a lot of different options. For example, a popular choice is the cash refund option, where you'll receive payments for the rest of your life, and if you pass away before getting your initial principal back, the difference will go to your beneficiary.

"There are also 'period certain' options, where you can choose a certain period of time for payments to be guaranteed. So if you decide on a 10-year option, you'll get payments for life no matter what. But if you pass away before ten years are up, your beneficiary will receive payments for the remaining time. With so many payment choices, it's best to talk to an agent about what's right for you."

Get Started Today

Want to talk through your own retirement goals and discuss how an annuity could provide guaranteed income during your retirement years? Your local State Farm agent is here to help.

1 Federal income tax-deferral is provided by the tax-qualified retirement plan. No additional tax-deferral is provided by an annuity.

Neither State Farm® nor its agents provide tax or legal advice.

Please consult your tax, legal, or investment advisor regarding your specific circumstances.

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