An annuity is a financial contract between you and an insurance company. Like a CD, it requires deposit of money
up-front (known as a “premium”) that you expect to receive at a later period combined with growth. Unlike
a CD, the insurance company (contract holder) guarantees the annuity instead of the Federal Government, and money is received
in retirement as a (monthly) income stream instead of on a “maturity date”. With an annuity you may receive
significantly more money than you’ve invested or much less depending on contract terms and your lifespan. The
return on several types on annuities (variable and indexed) also depends on investment growth.
A qualified (tax deferred) annuity is simply an account where taxes have not yet been paid on the principal. Common
examples of a qualified account are IRA’s, 403(b)’s, 401(k) rollovers and various other retirement plans.
deferred annuities have for years been a popular alternative for people who want high interest and tax relief for their savings.
In the last 20 years, billions of dollars have been moved into these contracts by savers seeking safety and predictability,
competitive interest rates and favorable tax treatment. One of the most important features of a tax-deferred annuity
is that it allows you to compound yearly interest earnings free of current tax. By eliminating the current tax cost
of accumulation, you can build a much larger account value than with a typical interest bearing account such as a bank CD.
deferred annuities are great for safely accumulating money to be used at some future date to enhance income; as long as it
is understood that when you begin to withdraw money from the annuity, you must then pay taxes on your gain. All distributions
from a qualified annuity (principal, interest, and investment gains) are subject to income taxes, and you are required by
the IRS to take mandatory minimum distributions at age 70 ½.
Non Qualified Annuities
A non qualified annuity is one where taxes have already been paid on the principal investment. Deposits could come from
a mature certificate of deposit, a checking or savings account, a brokerage account, or an existing non-qualified annuity.
Only the earned interest is considered taxable in a non-qualified annuity, and you will never be forced by the government
to take your interest or principal out at any age.
IRA Rollover/Transfer to an Annuity
Like many Americans, you may own an IRA. One of the most common misconceptions among IRA owners is that they must
keep their IRA where it is, which is not the case. As an owner of an IRA, you have complete control over where you invest
your IRA funds. If you are unhappy with its current rate of return or the service you are receiving from the institution
where your IRA is presently held, you can transfer your IRA to another IRA qualified investment without penalty or having
to pay any income tax. This is done via an IRA Rollover or a Direct Transfer.
Annuity products are a safe and
secure alternative and have interest rates that are better than most bank CDs, Savings Accounts or Money Market Funds. Also,
if your IRA is currently in a Mutual Fund and you are concerned about the risk to your principal, an Annuity is an excellent
way to guarantee your principal with an opportunity for greater growth.
Immediate Payment Annuities
Annuities can be either immediate or deferred, meaning that they can immediately begin to provide income
or begin at a future date, allowing the premium to grow tax-advantaged.
With Immediate Annuities (sometimes called income
or payout annuities), you give an insurance company a lump sum of cash in return for regular income payments that start immediately
and usually continue until you die. They are commonly bought when you're ready to liquidate your other investments to
start receiving regular monthly income.
One advantage of an immediate payment annuity is high payout. Let’s
say you invest $100,000 and request an immediate payout. Depending on your situation and the choices you make, you might
receive as much as $600 a month. That’s better than a 7% return, which is very attractive in the current market
environment. Your income isn’t FDIC-insured, but it is backed by the insurance company you bought the annuity
from, and the annuity is not subject to the ups and downs of the stock market.
There are also some disadvantages of
immediate payment annuities. One disadvantage is that an immediate annuity is irreversible once it has been purchased.
This may pose a problem should the annuitant want to change the monthly payout amount or need access to capital to deal
with an emergency.
Also, the payout isn’t the return on your investment. It’s a combination of principal
and interest. So, in the example above, while this person might be receiving a payout of 7.2%, most of it could be the
investor’s own money.
Another large drawback of an immediate annuity is that it is terminated upon death
of the annuitant. This means that in the event of the annuitant's premature death, the size of the estate left to his
or her heirs may be much smaller than it would have been if the immediate payment annuity had not been purchased. For
this reason an immediate annuity is not recommended for retirees who are in poor health.
In summary, an immediate payout
annuity might be right for you if you mostly care about maximizing your retirement income, are in good health and don’t
need access to your capital.
Deferred Annuities have two phases: accumulation phase and payout (or annuitization) phase. During the accumulation
phase, you can add funds to your annuity contract by depositing cash, converting life insurance cash values or doing a 1035
exchange from another annuity (to name a few ways of contributing). If you follow the annuity rules, your annuity will
accumulate earnings on a tax-deferred basis until you make withdrawals.
The second (payout) phase provides a monthly
income to you for as long as you choose. Taxes are paid on the income you receive from a deferred annuity. The
amount of income that is taxed depends on whether your annuity contributions are pre-tax or after tax. Taxes are paid
on all pre-tax contributions and the accumulated growth. See the Annuity Income section of this website for more details.
three major types of annuities are Fixed, Variable and Indexed.