Annuity Basics

Annuities vs. Pensions

If you are retiring soon and want to turn your nest egg into a stream of income, there are some key issues to consider such as access to your investments, security of income, and the opportunity for your funds to keep growing. Annuities and pensions are two different types of retirement assets, which serve as sources of retirement income. Pensions are defined benefit plans and they provide a guaranteed monthly income benefit for the entire life after retirement. An annuity isn’t funded by the employer, as a pension would be. It is a financial product that can be purchased from the insurance companies, financial groups, banks, or independent brokers. Similar to the pension fund, an annuity provides regular monthly income for the rest of your life, and potentially the rest of your partner’s life, and could be structured to disburse funds for a guaranteed period of time, regardless of the annuitant’s life expectancy. Below is the comparison between pensions and annuities to give you a better idea of what to choose as your retirement option.

Access to Capital: Annuities allow no access to capital, while in case of pensions, individuals have full access to their funds. When an individual buys an annuity, he/she gets monthly guaranteed sums or as agreed in the contract, but they are unaware as to how the rest of the sum is invested. However, in pension schemes, they have greater access to their savings as they can change the payment amounts within certain limits if needed as well as pull out a big lump sum.

Income Stability: Majority of the people want a steady income stream to fund their retirement years. If you consider income stability as your top priority, mull over the annuities option as it provides you with definite income payments during your retirement, regardless of what the stock and bond markets are doing. Pensions, however, provide low-income stability when compared to annuities and its varied options as your income comes to an end when all your lump sum money is over. To overcome this, you may have to establish an investment strategy to generate a substantial income so as to make your savings last longer.

Income Guarantee: The insurance companies or other financial institutions provide a definite amount of money to the annuitants depending upon the sum invested by them for rest of their lives unless they opt for guaranteed period benefit annuities. Pensions, on the other hand, guarantee a given amount of monthly income on retirement and place the investment risk on the employee. However, there are a few options available which offer the flexibility of pension funds with the security of guaranteed earnings for life, one of which includes investing the pension funds in buying annuities.

Tax Advantages: Pensions and annuities have their own tax advantages. Employee and employer contributions under a pension fund pact are paid from pre-tax income. Annuities, on the other hand, are tax-deferred accounts that are funded with after-tax income. However, just like pre-tax accounts, once funded you do not have to pay tax on the capital gain earned until you take a withdrawal. The downside is that you do not get to take benefit of the lower tax rates as investment income in both the cases will be taxed the same way – as ordinary income upon withdrawal.

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