An annuity is a contract between you and an insurance company that allows you to accumulate money on a tax-deferred basis and arrange for a systematic stream of income payments, usually when you retire. Variable annuities are subject to investment risks, including the possible loss of principal.
What are the major advantages of an annuity?
Interest (earnings) accumulates income tax deferred until dollars are withdrawn. This helps clients build substantial funds for their retirement and can give them an income they cannot outlive.
Yes, insurance companies are the only financial institutions that may underwrite and issue annuity contracts. Fixed Annuity values are backed by the general assets of the insurance company. The Department of Insurance in each state must issue licenses to the insurance company and their agents who solicit business in that state.
What assets can be contributed into an annuity?
Maturing CDs, checking and savings accounts, money market funds, mutual fund accounts, stock and bond funds, IRA rollovers, Treasury bonds and bills.
No. Dollars earmarked for short-term needs should not go into the annuity. In addition, at least six months of income should be saved for emergencies outside of the annuity. Also, those who need current income should consider an immediate annuity, not a deferred annuity. On the other hand, those looking for one of the safest ways “to accumulate” dollars on a tax-advantaged basis will find the deferred annuity extremely beneficial.
No, the IRS considers that interest earnings are withdrawn first. Naturally, any portion of a withdrawal exceeding interest earned would be a tax-free return on principal.
How can an annuity provide me with retirement payments as long as I live?
If you annuitize your contract and choose a lifetime income option, you are guaranteed a stream of payments you cannot outlive, backed by the claims-paying ability of the issuing insurance company. (This guarantee does not apply to the investment performance of a variable annuities underlying investment options.)
What is the accumulation phase of an annuity contract?
This refers to the period in which you make premium or purchase payments to the contract. These payments grow on a tax-deferred basis until withdrawn. Withdrawals of taxable amounts are subject to income tax and, prior to age 59½, the IRS may impose a 10% penalty. A surrender charge may be imposed by the insurance company if a withdrawal is made in excess of the free withdrawal amount during the early years of the contract.
What is the payout phase of an annuity contract?
The payout, or income phase, refers to the period when you will receive regular income payments from the annuity. Income payments are based on the value of the contract at the time the option is elected. Income guarantees are backed by the claims-paying ability of the issuing company.
What payout options are available?
Period certain–Income is guaranteed for a predetermined period of time.
Life with period certain–Income is guaranteed for the rest of your life or for a predetermined period of time, whichever is longer. If you die before receiving the minimum number of guaranteed payments, the remaining balance is paid to your beneficiary.
Joint and survivor–Income is guaranteed for the lifetime of two persons (typically spouses) for as long as either is alive. A period certain may be added to this option.
Life only–You will receive income for the rest of your life. Payments cease at death of owner with no payments to the beneficiary.
How can I jump-start my annuity savings?
Premium-enhanced or bonus annuities offer the purchaser a purchase payment credit, or bonus, on their premium. This credit is a percentage applied to the purchaser’s premium payment.
Purchase payment credits are treated as earnings for distribution purposes and may be subject to income tax.
What should I consider when choosing a fixed annuity?
Since the rate of return is fixed, it is important to consider the effects of inflation on your investment. It is also important to note that the assets are invested in the insurance company’s general account and are therefore subject to the claims of its creditors. With this particular type of annuity, you will want to consider the financial strength of the issuing company. Consumer rating services such as A.M. Best and Standard & Poor’s provide such information.
Why would I choose an annuity for my qualified plan?
Annuities offer no additional tax deferral than that offered by a qualified plan and investors should always consider contributing the maximum allowable to their qualified plans before investing in annuities. Withdrawals from qualified plans and annuities of taxable amounts are subject to income tax and, before age 59½, a 10% IRS penalty. Surrender or withdrawal charges may also apply for annuities. There are, however, benefits you may want for your qualified plan that are available only in a variable annuity.
For an additional fee, many insurance companies also offer living benefits—guarantees to protect your accumulated assets during your lifetime and provide a regular stream of income during retirement.
Such guarantees, backed by the claims-paying ability of the issuing insurance company, have helped make the variable annuity popular among investors saving for retirement.
How does a living benefit work?
Living benefits can assure you a minimum monthly income when you begin taking payments, or the return of your original investment, regardless of the value of your annuity contract when you activate the benefit. You pay for these optional guarantees only if you want them. They typically have a vesting period and are backed by the claims-paying ability of the issuing insurance company. Some are irrevocable. Guarantees and fees vary by contract. Read the prospectus for complete details.
Why invest in an annuity if I already have an IRA and participate in a 401(k) plan?
Each year, the amount you can contribute to an IRA or 401(k) is governed by IRS rules. There are penalties for withdrawals before age 59½, as well as rules that dictate when you must begin withdrawing money.
Annuities in nonqualified plans, where contributions are not deducted from current income taxes, place no limits on your after-tax contributions other than those set by the insurance company and have no deadlines that tell you when you must begin withdrawing. Annuities purchased in qualified plans are subject to minimum distributions required by the IRS. This can help you save more on a tax-deferred basis and keep more of your long-term earnings for use during retirement. Withdrawals from qualified plans and annuities of taxable amounts are subject to income tax and, before age 59½, the IRS may impose a 10% penalty. Surrender or withdrawal charges may also apply for annuities.
Why is it important to start saving now for retirement?
Americans are living longer. Retirement will be a bigger part of your life. How comfortable it is depends in part on how you supplement Social Security and pension payments with your own personal savings plan on a qualified or nonqualified basis.
The sooner you begin saving, the better. In its Saving Fitness guide, the Department of Labor estimates that for every ten years you delay saving, you will need to save up to three times as much each month to earn the same amount for your retirement.
How do tax-free annuity transfers work?
Internal Revenue Code Section 1035 allows you to exchange one annuity contract for another, or exchange a life insurance contract for an annuity–without having the transfer treated as a taxable event. A 1035 exchange may be appropriate if you own an older contract and wish to avail yourself of recently-created death benefit options, or if the performance of your subaccounts has been not been good. There are costs associated with exchanging annuities including potential surrender charges.
How do “stepped-up” death benefits work?
If you die before receiving income from your annuity, the death benefit provides your beneficiary with a guaranteed benefit, one that does not have to go through probate. Some contracts offer optional “stepped-up” benefits which guarantee a minimum yearly percentage increase for your account and/or a minimum return on the value of your account. See the prospectus for detailed information on restrictions, limitations and fees for death benefit options. Death benefits are backed by the claims-paying ability of the issuing insurance company.
What IRS reporting is required for annuity owners?
Unless withdrawals are made, or an annuitization option elected, there is no tax reporting on deferred annuities. At death, the value of the contract is included in the estate of the annuity owner. Any gains in the contract will be taxable to any beneficiary except surviving spouse.
A surviving spouse beneficiary may elect to continue the contract indefinitely, thereby postponing any current income tax liability. As with any investment, you should check with your tax or legal advisor regarding your personal situation.
