Annuity Types
Deferred Annuities
This is a type of annuity contract that delays the payments of income, installments or a lump sum until the investor elects to receive them. This type of annuity has two main phases, the accumulation phase in which you invest money into the tax deferred account, and the income or payout phase in which the plan is converted into an annuity and payments are received.
Acting much like CDs, deferred annuities accumulate interest over time. This differs from fixed immediate annuities, which pay out in monthly installments as soon as the contract starts (typically after 30 days).
Even though deferred annuities are designed to accumulate money, most annuity contracts include a "free withdrawals" provision, which allows the owner to take out anywhere from 5%-20% per year penalty free, depending on the specific contract rules. Any amount taken beyond this limit is subject to fees and surrender charges, so be sure to ask your financial professional what amount would be available to you each year.
Reasons for Savings in Deferred Annuities
The most significant benefit deferred annuities offer over CDs and other similar investment vehicles is tax-deferral. A CD would be taxed yearly and annuity income isn't taxed until it's withdrawn. The result of this is that 100% of the interest accumulated each year in a deferred annuity would stay in the policy and continue to compound interest.
The advantages of tax-deferral really start to kick-in over time, so it's in the deferred annuity investor's interest to opt for longer terms. An ideal deferred annuity investor starts saving for retirement early and gives plenty of time for the account to compound.
Another important benefit of deferred annuities is their multi-premium nature, allowing you to start with a smaller investment. One problem with immediate annuities is that they need to be funded with large up front premiums, which isn't always available. This is necessary because payouts start immediately and there's no time for your money to grow. A deferred annuity, however, like a 401(k), is designed to accommodate continuing contributions throughout the contract term. This allows investors to start small and work their way up to a sizeable retirement nest egg incrementally.
This is a type of annuity contract that delays the payments of income, installments or a lump sum until the investor elects to receive them. This type of annuity has two main phases, the accumulation phase in which you invest money into the tax deferred account, and the income or payout phase in which the plan is converted into an annuity and payments are received.
Acting much like CDs, deferred annuities accumulate interest over time. This differs from fixed immediate annuities, which pay out in monthly installments as soon as the contract starts (typically after 30 days).
Even though deferred annuities are designed to accumulate money, most annuity contracts include a "free withdrawals" provision, which allows the owner to take out anywhere from 5%-20% per year penalty free, depending on the specific contract rules. Any amount taken beyond this limit is subject to fees and surrender charges, so be sure to ask your financial professional what amount would be available to you each year.
Reasons for Savings in Deferred Annuities
The most significant benefit deferred annuities offer over CDs and other similar investment vehicles is tax-deferral. A CD would be taxed yearly and annuity income isn't taxed until it's withdrawn. The result of this is that 100% of the interest accumulated each year in a deferred annuity would stay in the policy and continue to compound interest.
The advantages of tax-deferral really start to kick-in over time, so it's in the deferred annuity investor's interest to opt for longer terms. An ideal deferred annuity investor starts saving for retirement early and gives plenty of time for the account to compound.
Another important benefit of deferred annuities is their multi-premium nature, allowing you to start with a smaller investment. One problem with immediate annuities is that they need to be funded with large up front premiums, which isn't always available. This is necessary because payouts start immediately and there's no time for your money to grow. A deferred annuity, however, like a 401(k), is designed to accommodate continuing contributions throughout the contract term. This allows investors to start small and work their way up to a sizeable retirement nest egg incrementally.
Immediate Annuities
Immediate Annuities convert a lump sum amount of money into guaranteed income to the annuitant as soon as the annuity is purchased. The annuitant may choose from a lifetime income stream, which provided the income for life, or a set time frame (usually 5, 10 or 20 years). Whatever the annuity purchased, there are essentially two ways it can pay out, either immediately or at a later date (deferred). An immediate fixed annuity is what most people think of as you start to receive periodic checks after the first month of investment.
Checks are typically issued monthly, but can also be semi-monthly, quarterly, and semi-annually. This contrasts with fixed deferred annuities that automatically re-invest interest and pay out at the end of the term in one lump sum.
Advantages of Immediate Lifetime Annuities
With social security payments in decline, an average annual inflation rate of 3%, and advances in healthcare, outliving their retirement savings is becoming more and more likely for the average American.
Immediate annuities are one of the only investment vehicles that can protect against this likelihood. No other investment guarantees a lifetime income you can't outlive.
Retirement planning based on life expectancy is getting tougher. The average 65-year-old healthy American male is expected to live until 85. But, there's 50% chance of living past 85, and a 25% chance of living past 92. Underestimating your life expectancy should be a blessing, but can turn into a curse if you can't cover basic living expenses.
Immediate annuities can insure you against this possibility. Moreover, studies have found that 25-40% more money would be required to have this assurance with an annuity-free retirement portfolio.
Who Should Buy Immediate Fixed Annuities
Immediate fixed annuities are ideal for investors with a 3 - 5 year time horizon who need a steady source of income, like retirees. If you want maximum growth and don't need guaranteed paychecks, fixed deferred annuities are a better alternative.
Think of immediate fixed annuities as a retirement income booster. You have $100,000 in savings that you plan to use for retirement over the next 5 years. Rather than leaving it in the bank or a low-interest money market account, you give it to the insurance company at a rate of 6% (for instance).
The insurance company calculates $133,822 ($100,000 x 1.06 compounded over 5 years) and divides it by 60 months to yield a monthly payment of $2,230.
Had you not purchased the annuity, you'd have $560 less to spend per month.
Checks are typically issued monthly, but can also be semi-monthly, quarterly, and semi-annually. This contrasts with fixed deferred annuities that automatically re-invest interest and pay out at the end of the term in one lump sum.
Advantages of Immediate Lifetime Annuities
With social security payments in decline, an average annual inflation rate of 3%, and advances in healthcare, outliving their retirement savings is becoming more and more likely for the average American.
Immediate annuities are one of the only investment vehicles that can protect against this likelihood. No other investment guarantees a lifetime income you can't outlive.
Retirement planning based on life expectancy is getting tougher. The average 65-year-old healthy American male is expected to live until 85. But, there's 50% chance of living past 85, and a 25% chance of living past 92. Underestimating your life expectancy should be a blessing, but can turn into a curse if you can't cover basic living expenses.
Immediate annuities can insure you against this possibility. Moreover, studies have found that 25-40% more money would be required to have this assurance with an annuity-free retirement portfolio.
Who Should Buy Immediate Fixed Annuities
Immediate fixed annuities are ideal for investors with a 3 - 5 year time horizon who need a steady source of income, like retirees. If you want maximum growth and don't need guaranteed paychecks, fixed deferred annuities are a better alternative.
Think of immediate fixed annuities as a retirement income booster. You have $100,000 in savings that you plan to use for retirement over the next 5 years. Rather than leaving it in the bank or a low-interest money market account, you give it to the insurance company at a rate of 6% (for instance).
The insurance company calculates $133,822 ($100,000 x 1.06 compounded over 5 years) and divides it by 60 months to yield a monthly payment of $2,230.
Had you not purchased the annuity, you'd have $560 less to spend per month.
Traditional Fixed Annuities
The traditional fixed annuity is structured very similarly to a bank CD (certificate of deposit). The premium grows at a guaranteed fixed interest rate for a set amount of time from 1 year, to as long as 15 years.
Fixed Indexed Annuity Features
Returns Linked to the Market — Rate of return is linked to an index like the S&P 500, although no funds are directly invested in any equities market. It simply looks at the markets return over a period of time (usually one year intervals) and credits the annuity based on the market’s performance...
Minimum Guaranteed Rate — As with all fixed annuities, a minimum rate of return is provided in the contract. No matter how much the market drops, the account value will never decrease.
Low Risk — Can't lose principal. Money can only be lost if you withdrawal monies prematurely or the insurer becomes insolvent and your investment exceeds state annuity insurance.
Good Growth — Ideal of investors looking for stock market growth and coverage against bad years. Good retirement vehicle.
Variable Returns — Annual rate of return varies based on index performance.
Hassle Free — No micro management. Sign the contract and deposit the funds.
Vesting Schedule — Withdraw earnings early without penalties up to certain amounts.
1-10 Year Term — Index annuities are available for short, medium, or long terms
Tax Deferral — Pay nothing on interest earned until you cash out.
Unlimited Contributions — Invest as much as you'd like tax-free.
Life Insurance — Optional life insurance provision offers death benefits to loved ones.
Inheritance — Bequeath money to loved ones probate-free. Avoid estate/death taxes.
Tax-Free Gifts — Gift up to $13,000 per individual, per year, tax-free. Gift money to an unlimited number of individuals.
Fixed Annuity Disadvantages
Fixed annuities are typically considered long-term investments
10% IRS Penalty - Any income withdrawn from an annuity prior to age of 59.5 are typically charged a 10% tax penalty by the IRS.
Limited Liquidity - Fixed annuities are designed to either be distributed over a determined number of payments, or designed with a predetermined deferral period. Most fixed annuities offer an annual "free withdrawal" to the client. However, there are fees and penalties associated with any withdrawals that surpass the allotted percentage. Before purchasing a specific annuity, be sure to determine what percentage of funds are available each year.
Income is taxed as ordinary income - While the tax-deferred attributes of fixed annuities are beneficial to growth, once payments begin, income is taxed as ordinary income and not considered capital gains.
Fixed annuity contracts can be complicated - The details of a fixed annuity will vary greatly from product to product. These differences can make a big difference as to how the investment actually functions. Minor details make a big difference. Learning and understanding the details of a specific annuity can be time consuming, but is extremely important if you wish to match a product with your specific investment goals.
Fixed Annuities are often criticized for having high surrender charges. As with any investment, fixed annuities have their pitfalls, but knowing what to look for in an annuity will help avoid many problems:
Don't purchase fixed annuities with money you may need immediate access to. Early withdrawals are subject to fees.
Find out how low the interest rate can go. Many fixed annuities are structured with an interest rate that may change over time. When purchasing an annuity, make sure you know how long the rate is guaranteed for and how low the rate can go.
Withdrawal Charges: Early withdrawals from a fixed annuity may incur a surrender charge. Make sure you ask what percentage you can take out in 'free withdrawals'.
Free Withdrawals Provisions: Annual penalty-free withdrawals might exclude principal.
Fixed Indexed Annuity Features
Returns Linked to the Market — Rate of return is linked to an index like the S&P 500, although no funds are directly invested in any equities market. It simply looks at the markets return over a period of time (usually one year intervals) and credits the annuity based on the market’s performance...
Minimum Guaranteed Rate — As with all fixed annuities, a minimum rate of return is provided in the contract. No matter how much the market drops, the account value will never decrease.
Low Risk — Can't lose principal. Money can only be lost if you withdrawal monies prematurely or the insurer becomes insolvent and your investment exceeds state annuity insurance.
Good Growth — Ideal of investors looking for stock market growth and coverage against bad years. Good retirement vehicle.
Variable Returns — Annual rate of return varies based on index performance.
Hassle Free — No micro management. Sign the contract and deposit the funds.
Vesting Schedule — Withdraw earnings early without penalties up to certain amounts.
1-10 Year Term — Index annuities are available for short, medium, or long terms
Tax Deferral — Pay nothing on interest earned until you cash out.
Unlimited Contributions — Invest as much as you'd like tax-free.
Life Insurance — Optional life insurance provision offers death benefits to loved ones.
Inheritance — Bequeath money to loved ones probate-free. Avoid estate/death taxes.
Tax-Free Gifts — Gift up to $13,000 per individual, per year, tax-free. Gift money to an unlimited number of individuals.
Fixed Annuity Disadvantages
Fixed annuities are typically considered long-term investments
10% IRS Penalty - Any income withdrawn from an annuity prior to age of 59.5 are typically charged a 10% tax penalty by the IRS.
Limited Liquidity - Fixed annuities are designed to either be distributed over a determined number of payments, or designed with a predetermined deferral period. Most fixed annuities offer an annual "free withdrawal" to the client. However, there are fees and penalties associated with any withdrawals that surpass the allotted percentage. Before purchasing a specific annuity, be sure to determine what percentage of funds are available each year.
Income is taxed as ordinary income - While the tax-deferred attributes of fixed annuities are beneficial to growth, once payments begin, income is taxed as ordinary income and not considered capital gains.
Fixed annuity contracts can be complicated - The details of a fixed annuity will vary greatly from product to product. These differences can make a big difference as to how the investment actually functions. Minor details make a big difference. Learning and understanding the details of a specific annuity can be time consuming, but is extremely important if you wish to match a product with your specific investment goals.
Fixed Annuities are often criticized for having high surrender charges. As with any investment, fixed annuities have their pitfalls, but knowing what to look for in an annuity will help avoid many problems:
Don't purchase fixed annuities with money you may need immediate access to. Early withdrawals are subject to fees.
Find out how low the interest rate can go. Many fixed annuities are structured with an interest rate that may change over time. When purchasing an annuity, make sure you know how long the rate is guaranteed for and how low the rate can go.
Withdrawal Charges: Early withdrawals from a fixed annuity may incur a surrender charge. Make sure you ask what percentage you can take out in 'free withdrawals'.
Free Withdrawals Provisions: Annual penalty-free withdrawals might exclude principal.