Annuities

An annuity is a contract issued by an insurance company. It is a unique financial product that provides tax deferral of interest and the option of a guaranteed monthly income for life.

The primary purposes of an annuity are safety, growth, income and tax deferral for the "annuitant", the person who will receive the future income stream.

The money accumulating inside the annuity grows on a tax deferred basis, and for fixed annuities, they are guaranteed against risk of loss.

There are two parts to an annuity: the accumulation phase and the distribution phase.

The Accumulation Phase

Features

  • During the accumulation phase, funds grow tax deferred. If the annuity is not part of a "qualified" retirement program (such as an IRA, 401(k) or TSA) income taxes are paid on gains when money is withdrawn. If the annuity is part of a qualified plan, then the entire amount is taxable at withdrawal or surrender.
  • Most annuities offer partial withdrawals free of surrender charges. Larger early withdrawals incur surrender charges.
  • If you withdraw money from your annuity before age 59 1/2 it is a "premature distribution" and is subject to an additional 10% penalty by the IRS.
  • If a premature death should occur, the accumulated funds within the annuity may be transferred to the named beneficiary, avoiding probate costs and immediate taxes.
  • Annuities are available as "single premium" (purchased with a one-time payment) or "flexible premium" (purchased with recurring periodic payments). They are available as a "deferred annuity" (income payments are deferred) or as an "immediate annuity" (income starts immediately).
  • For fixed and equity-indexed annuities, safety of principal is guaranteed, and annual gains are typically locked in ("reset") and not at risk of loss.

Types


  • Fixed annuities
  • Variable annuities
  • Fixed “equity Indexed” annuities
Fixed Annuities
  In a fixed annuity, the insurance carrier:

  • Declares a current rate of interest for a specified time period. Once the time period expires the company will set a new rate which may be higher or lower than the original rate.
  • Guarantees a minimum interest rate specified in the contract; at no time may the current or renewal interest rate fall below the guaranteed minimum.
  • Guarantees the principal.

Variable Annuities
  • In a variable account, the annuity owner bears investment risk. Policy values vary directly with market performance and may result in a loss of principal and prior earnings. Earnings are tied directly to the performance of underlying investment vehicle-- mutual funds-- which are available within the annuity and are selected by the owner.

  • Variable annuities offer a guarantee that in the event of death the beneficiary will receive at least all the premiums paid less any withdrawals made no matter what the value of the account at the time of death. If the account fund falls below the original principal investment, the beneficiary will receive the original investment.
  • Equity Indexed Annuities

    An Equity-Indexed Annuity (EIA) offers gains linked to growth in equity markets as measured by an index, such as the S&P 500. The EIA owner enjoys the upside potential of equities but is not exposed to downside risk.

    Subject to fixed minimum guarantees, the value of an EIA can only increase due to market growth, it will never decline due to market downturns. There are many variations in product design. No two EIAs are exactly alike.

    Withdrawals

    Withdrawals may be made at any time. However, the withdrawal may be subject to surrender charges. Contracts vary as to the amount of free withdrawals, but typically offer a 10% annual free withdrawal provision.

    Annuitization

    When the owner "annuitizes" an annuity, he or she opts for a payout plan. In a fixed or equity indexed annuity, the owner can choose a monthly income that will be paid for a period of time or for life.

    Annuity Pay Out Plans

    Life Only- Periodic monthly payments to an annuitant for the duration of his or her lifetime. The annuitant cannot outlive the payments. The payments are determined at the time of annuitization.

    Life with 10 years certain-Payments will be made for at least ten years, regardless whether the annuitant lives for the entire ten years or not. If the annuitant dies during the ten-year period, the remainder of the payments will be made to a beneficiary. If the annuitant lives longer than ten years, he or she will continue to receive payments (for life).

    Life with 20 years certain-Payments will be made for at least twenty years, whether the annuitant lives for the entire twenty years or not.

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