Understanding Annuities
Annuity? What the What?!
At its simplest, an annuity is an insurance contract that will fund equal and regular payments in the future and you can purchase them two ways. The first way is with monthly premiums, the second way to purchase an annuity is with a large lump sum. The future payments fund your retirement and will be paid out for a specified period or the rest of your life. This strategy is a great way to insure your future financial health because, let’s be real, nobody wants to outlive their money.
Annuity products are regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). Only agents holding a state-issued life insurance license can issue annuities, a securities license is needed in addition in the case of variable annuities.
Great, But How Do They Work?
Would you like to NOT worry about money flowing to your bank account in your leasiure years? Of course! Annuities keep a steady flow of cash coming to you so you don’t have to sacrifice your standard of living which is why those in the know seek out insurance companies to purchase an annuity.
If you need immediate liquidity and are younger, there are specific annuities for you but in general annuities are for those who don’t need to touch their money until retirement.
Let’s look at what happens within the annuity.
The accumulation phase is the phase before payouts begin. It’s the period of time when an annuity is being funded and money is growing making it inaccessible, unless you’re okay with paying a penalty. Any money invested in the annuity grows tax-deferred during this stage.
The annuitization phase, starts once pay outs begin.
This type of product can be either immediate or deferred. Immediate annuities are usually purchased by people, regardless of age, who have received a windfall of money like a settlement or lottery win, and who prefer to exchange it for guaranteed future cash flow. Deferred annuities are structured to grow tax-deferred and provide guaranteed income beginning on a specified date.
Things To Think About
What age do you want income to begin? Interest rates vary depending on the payment terms and duration of the annuity.
What are the income rider fees? Some products offer the income rider free of charge, however most have fees attached.
Immediate and Deferred Annuities
Annuities can begin immediately upon deposit of a lump sum, or they can be structured as deferred benefits. The immediate payment annuity option begins paying immediately after the annuitant deposits a lump sum. Deferred income annuities begins when you specify an age you’d like to begin receiving payments from the insurance company.
Fixed Annuities. Variable Annuities. Index Annuities.
Annuities can be structured generally as either fixed or variable:
Fixed annuities provide regular periodic payments to the annuitant.
Variable annuities allow the owner to receive larger future payments if investments of the annuity fund do well and smaller payments if its investments do poorly, which provides for less stable cash flow than a fixed annuity but allows the annuitant to reap the benefits of strong returns from their fund's investments.
Index annuities are a hybrid of Fixed and Variable annuities as they offer the best features of the two giving the owner a vehicle to grow their money when the market grows while the client can enjoy peace of mind with the guarantee of protection from any market loss.
Is It Right For Me?
One criticism of annuities is that they are not liquid. Deposits into annuity contracts are typically locked up for a period of time, known as the surrender period, where the annuitant would incur a penalty if all or part of that money were touched.
These periods can last anywhere from two to more than 10 years, depending on the particular product. Surrender fees can start out at 10% or more and the penalty typically declines annually over the surrender period.
Who Are Annuities Best For?
Annuities are appropriate financial products for those seeking stable, guaranteed retirement income. Because the lump sum put into the annuity is illiquid and subject to withdrawal penalties, it is not recommended for those who value immediate liquidity over growth. Annuity holders cannot outlive their income stream, which hedges longevity risk.
What Do You Mean By A Non-Qualified Annuity?
Annuities can be purchased with either pre-tax or after-tax dollars. A non-qualified annuity is one that has been purchased with after-tax dollars. A qualified annuity is one that has been purchased with pre-tax dollars. Qualified plans include 401(k) plans and 403(b) plans. Only the earnings of a non-qualified annuity are taxed at the time of withdrawal, not the contributions, as they are after-tax money.
Let’s Break It Down Some, OK?
Annuities provide a guaranteed income stream for retirees and others depending on the contract.
The annuity is funded with a lump sum or monthly payments. This is called the accumulation phase.
After annuitization, payments will be made to you for either a fixed amount of time or the rest of their life.
Fixed, Variable, and Index annuities can be either immediate or deferred.
My firm understands that annuities and their tax implications can be confusing so we take care to explain how your money will be taxed and what you can expect with your future payouts.
