This page is meant to help you to learn about the basics of annuities.
We start with a basic definition and the tax advantages of annuities.
“What is an annuity?”
An annuity is a financial product that accumulates interest on a tax-deferred basis. It also provides for systematic annuity payouts at whichever schedule is selected and allowed for in the annuity contract. An annuity contract is not a life insurance policy or a health insurance policy. It is not an investment product, savings account or savings certificate, and it should not be bought for short-term purposes.
Types of Annuities:
The differences between annuities can be seen in the following areas:
- When Benefits are Received.
Annuities may be either immediate annuities or deferred annuities. Immediate annuities provide income payments that start shortly after you pay the annuity premium. Deferred annuities provide income payments that start at a later date. The main reason for buying an immediate annuity is to obtain an immediate income stream, generally for retirement income purposes. The most common reason that someone would purchase a deferred annuity is to accumulate money in a tax deferred manner which can then provide an income at a later date.
- Method for paying premiums.
Annuities may be purchased in a manner where there is only one premium payment or an annuity can be purchased that has multiple payments over time. Single premium contracts require you to pay the company only one premium. Other annuity contracts are designed for a series of premiums that typically lasts for multiple years. Most of these installment payment annuity contracts are flexible premium contracts. You pay as much as you wish whenever you wish, within specified limits. Some are scheduled premium contracts that specify the size and frequency of your premiums.
- Fixed Indexed
Annuities may be fixed or indexed, or a combination.
The insurance carrier declares a current rate of interest, guarantees a minimum rate of return, and guarantees the premium.
How much money should I put into an annuity contract? The following are key questions to ask and answer.
- How much income will I need from the annuity while in retirement, in addition to Social Security, pension savings and other investments?
- Am I the only person that needs income or will there be a spouse that also needs income?
- If I make installment payments, how much can I afford from a cashflow standpoint?
- How does the annuity fit into an overall financial strategy? Is it right for me in my specific situation?
Buying an annuity contract is a major financial decision which should be considered carefully.
- Be certain that you clearly understand all expenses/fees/charges that exist in the contract and understand how this will impact the efficiency of the annuity contract.
- Make sure that you do not get into an annuity contract that you ultimately cannot afford.
- Look to see if the annuity will allow for flexibility, allowing you to make changes to the amount that you pay into the contract, the frequency for when you can pay, etc, etc.
- Do an analysis of annuities that multiple carriers offer. The market is competitive and with the proper amount of “shopping”, you might end up with a contract that is better suited for you (with lower fees/charges, etc.). We can help you to do this.
- If the annuity is meant to be purchased inside some type of a tax qualified account, please make sure that you qualify. Speak with your tax accountant for clarification on if you qualify. Consider the fact that if you are making payments for years that your tax situation could change.
Popular Advantages of Tax-Deferred Annuities
Annuities can have favorable tax advantages when compared to some other strategies. Interest on checking and savings accounts, dividends from stocks and rental income from real estate is typically immediately taxable in the year earned. Interest that is credited in a tax deferred annuity is not taxed until the money is withdrawn.
Tax-Deferred Compound Growth
Deferral on taxes of growth in the annuity can make it an advantageous financial product when compared to other more typical taxable investment options.
In addition to deferring taxes and earning interest on money which would otherwise be paid as taxes – you may also exercise some control over the timing of taxation.
In early retirement years, you may have sufficient income from qualified retirement plans, rental income, or part-time work. If you don’t need additional income from the deferred annuity, or if you want to delay taxation until later retirement years when taxable income may be less, distributions can be simply postponed. Of course, IRS minimum distribution requirements must be met with a qualified annuity.
You not only have the flexibility to choose when you begin withdrawals, but the flexibility to choose how:
- As a lump sum distribution less withdrawal charges;
- As an income for a specific number of years;
- As an income for as long as you live;
- As an income for as long as you or your spouse live.
This flexibility also means decisions don’t have to be locked-in today which might prove inappropriate years from now.