Annuity 101…Real Basic Stuff
Annuities are "safe”…a lot of folks would like to have more retirement income that is safe.
Annuities are Insurance Contracts
The first thing to understand is that annuities are essentially contractual obligations from insurance companies. In exchange for funds you provide to the insurer, which are paid into the product during what is called its build-up phrase, you are provided certain things that are spelled out in your annuity contract. The most basic promise is the insurer's commitment to make regular payments to you. This is known as the annuitization phase of the product. The payments begin at a specified time and usually last for the rest of your life or, depending on the specifics of your annuity, the rest of your spouse's life as well.
Second, money put into an annuity contract can grow tax-free until funds are withdrawn. If funds are withdrawn during the build-up phase, or because the annuity has been terminated early, it is assumed that any earnings that have accumulated in the annuity are withdrawn first, and taxed as ordinary income. Assuming the annuity was funded with post-tax dollars, the return of those initial funds is considered a return of principal (remember, this is an insurance product) and is not taxed.
Once regular payments have begun in the annuitization phase, they are treated as a blend of earnings and return of principal, and taxed accordingly. This is viewed as a favorable form of taxation.
Payments Depend On Several Factors
When you purchase an annuity, the size of the ultimate payments you will receive depend on several basic factors -- how much money you're putting into the contract, how old you are, and how far off the beginning date is for payments to begin. The insurer knows, on average, how long you're going to live. And it also knows how much money it expects to earn from the funds you've placed into the annuity contract. The amount of money it's willing to pay you is thus a calculated bet on its part. And, yes, it's a bet where the odds are tilted in favor of the insurer, which is trying to make a profit on the transaction.
Annuities can be bought and activated right away or over time. In the case of an immediate annuity, the insurer's stream of payments begins right after it has received your money. In a deferred annuity, the payments don't begin until a future date specified in your agreement. You can fund an annuity with a single, lump-sum payment or with periodic payments.
In the most basic of annuities, the insurer promises to pay you a specified amount of money, beginning at a future date, for the rest of your life. When you die, any money you've placed in the annuity contract belongs to the insurer, not to your estate. Clearly, if you live a short time, the insurer does very well on the contract. If you live for a very, very long time, the insurer doesn't fare so well. That's the basic bet.
Most people, however, want more than this basic promise. They may, for example, want the insurer to make annuity payments to them or their heir for at least a minimum amount of time. If that time is, say, 10 years, then their estate gets those payments should the contract owner die before receiving 10 years of payments.
Often, one spouse wants to make sure that annuity payments continue for his life and, should he die, for the remaining life of his spouse as well. Lots of annuity contracts include that provision.
3 Types Of Annuities
There are generally three types of annuities — fixed, indexed, and variable.
- In a fixed annuity, the insurance company agrees to pay you no less than a specified rate of interest during the time that your account is growing. The insurance company also agrees that the periodic payments will be a specified amount per dollar in your account. These periodic payments may last for a definite period, such as 20 years, or an indefinite period, such as your lifetime or the lifetime of you and your spouse.
- In an indexed annuity, the insurance company credits you with a return that is based on changes in an index, such as the S&P 500 Composite Stock Price Index. Indexed annuity contracts also provide that the contract value will be no less than a specified minimum, regardless of index performance.
- In a variable annuity, you can choose to invest your purchase payments from among a range of different investment options, typically mutual funds. The rate of return on your purchase payments, and the amount of the periodic payments you eventually receive, will vary depending on the performance of the investment options you have selected.
Variable annuities are securities regulated by the SEC. An indexed annuity may or may not be a security; however, most indexed annuities are not registered with the SEC. Fixed annuities are not securities and are not regulated by the SEC.
Life Time Income
To summarize; people buy annuities to give them retirement income for the rest of their lives. An annuity contract can also be a safe means of building assets for other purposes with a more limited time span.
An annuity has tax advantages. In a deferred annuity, the interest credited to your account builds up free of current income tax. You pay no tax until you get the annuity's benefits. But, if you withdraw the accumulated value of annuity contract before retirement age, there can be significant tax penalties and current taxes that may have to be paid.
Annuities can be used to fund an Individual Retirement Account. They also may be used in Keogh-type retirement plans for the self-employed.
Seek Competent and Sincere Help
Seek the advice of a competent Financial Services Professional to help you select annuities suitable for you.
Sources: Insured Retirement Institute-IRI, Life Insurance Marketing Research Association-LIMRA and Securities Exchange Commission-SEC
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Jim Robinson posted on Monday, June 13, 2011
Tags: Long Term Care, Investments, Retirement Planning, Senior Citizen, Annuities
Posted in: Site News, Senior Citizens
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