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Annuity Plans

Annuity Basics

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An annuity is an insurance product which you buy that pays out income to you in your retirement. Annuities are a good choice for investors who want to receive a steady income. You buy an investment in an annuity which then makes payments to you on a future date or series of specific dates. The income you receive from an annuity can be paid out monthly, quarterly, yearly or even in a large payment.

The amount of your payments are determined by varying factors and the length of your payment period.

You can choose to receive payments for your entire retirement or for a fixed number of years. How much you receive depends on whether you choose for a guaranteed pay out or a series of payments determined by the performance of your annuity’s investments.

Anyone considering an annuity should do research to discover whether it’s an appropriate investment for their situation.

There are two types of annuities: immediate and deferred.

With a deferred annuity, your money is invested for a period of time until you begin taking withdrawals at retirement.

With an immediate annuity plan you begin to receive payments right after you make your first investment deposit. Many people purchase an immediate annuity as they approach retirement age.

A deferred annuity accumulates money and an immediate annuity pays out money. A deferred annuities may be converted into immediate annuities when the owner wishes to begin receiving payments.

Within these two categories, annuities can also be variable or fixed. This depends on whether the payout is a fixed sum or tied to market performance of the investments or a combination of both.

Money that you invest in an annuity earns income tax free. When you begin making withdrawals, your earnings are taxed at your regular income tax rate. 

The biggest advantages annuities offer is that they allow you to invest large amounts of cash and defer paying taxes.

There is not an annual contribution limit for an annuity. You may invest as much money for retirement as you wish, which is particularly beneficial for those that are closest to retirement age. All the money you invest compounds year after year without any taxation. The ability to keep every invested dollar working is a huge advantage.

You may opt to take a large one- time payment from your annuity at retirement or arrange guaranteed payments for period of time or for the rest of your life. The annuity can compliment other retirement income such as private pension plans or your public pension plan. Annuities can be great tax deferred investments but there can be many concealed or hidden fees. Do diligent research into any prospective annuity plan before you decide to invest in them.

Most annuities sold by insurance brokers or sales agents charge a commission that can be as much as 10%.

You’re may also have to pay surrender charges for taking money out of an annuity within the first few years after you buy a plan. The surrender charge is usually around 7% of your account value if you leave after one year. The fee then declines by one percent per until year seven. Some annuities may even come with more prohibitive surrender charges – up to 20% within the first year.

When investing in a variable annuity you’ll encounter high annual expenses. An annual insurance charge of 1.25% or more; annual investment management fees from 0.5% to more than 2% and fees for a variety of insurance riders totaling 0.6% or more.

All together you may end up paying 2% to 3% a year. Compare annuity investments to regular mutual fund that charges an average of 1.5% a year or index funds that charge less than 0.50% a year.

It is cost prohibitive to withdraw money from annuities and other retirement investments such as 401(k) or IRA  until you reach age 59½. Withdrawals made prior will be penalized with a 10% early withdrawal fee.

There are some investment companies that sell annuities without charging a sales commission or a surrender charge. These are direct-sold annuities unlike annuities sold by traditional insurance company and there isn’t any insurance agents involved. Thus there is no need to charge a commission. Many financial firms sell low-cost annuities. 

With a fixed rate annuity, you do not choose the investment mix – the insurance company will do this and agrees to pay you a pre-arranged fixed amount.

With a variable rate annuity, you choose the investment mix for your money. Mostly they are mutual funds set up within the annuity. The asset value of your account depends on the performance of the funds. You may also choose the option for payouts.

Income payouts are where you are guaranteed a specific payment amount for a set period of time (from five to 30 years). If you should die before the period ends your beneficiary will receive the remainder of the payments.

Or you can choose for a guaranteed income payout during your lifetime. However there is not a survivor benefit payout payment. The payouts can be variable or fixed. The payout amount is calculated by how much you invest and your life expectancy. At the time of death all payments stop – your beneficiaries will not receive any payments.

Another payout option is to receive income for life with a guaranteed period certain benefit. This is a combination of a life annuity and a period certain annuity.

You will receive a guaranteed payout for life that includes a period certain phase. If you should die during the period certain your beneficiaries will continue to receive the payment for the remainder of the period.

Then there is a joint survivor annuity option. Your beneficiary will continue to receive payouts for the rest of his or her life after you die. A good option for retiring couples.

If you must make withdrawals before you reach age 59½ you will be required to pay a 10% early withdrawal penalty plus income tax on your investment earnings.

Some type of annuities allow you to withdraw up to 10% of your investment without having to pay the surrender charge.

Is buying an annuity right for your situation?

You should consider an annuity if you have maxed out other tax-deferred retirement investment plans like a 401(k) or IRAs. A annuity’s tax-exempt income growth may make sense- especially if you are in a high-income tax bracket.

Annuities do have disadvantages. You must be willing to invest your money for years before you start receiving any benefits. Annuities may charge high fees as well. Annuity fee structures can be complicated. Insurance agents and other sales representatives selling them may promote positive features while clouding their drawbacks. Carefully review the annuity plan before deciding.

Investors should compare the fee structure with regular mutual funds which do not charge a surrender fee and management average annual expenses of less than 0.5% for index funds or about 1.5% for actively managed funds.

The earnings you withdraw from an annuity will be taxed as income no matter how long you have owned the account.

There is always the possible you could lose your money if the insurance company you invested with goes bankrupt. When you purchase a deferred annuity you are surrendering to an insurance company, money today that you will not receive back for a number of years (the earliest you can make withdrawals from an annuity without incurring a 10% penalty is age 59 ½). So it is important to purchase annuities only from well known reputable insurance companies who you’re confident will be in still in business when you retire.

Research the insurer’s credit rating from major credit ratings agencies like Standard and Poor’s, Moodys or Fitch’s rating services. As a general rule, limit your options to insurers that receive either an A+, AA- or better from Moody’s, Fitch’s and S&P. You can find the ratings agencies online or get information from your insurance agent.

There are state guaranty funds that protect annuity owners if an insurance company goes bankrupt but the protection is limited and varies from state to state. Check with your state’s consumer protection agency for more information on bankruptcy protection from annuity investments.

Carefully read the sales disclosure documents and make sure you are aware of all potential fees. Don’t rely on the salesperson’s explanation alone.

Be cautious with exchanging your existing annuity for a new annuity purchase. Annuity exchanges are known as 1035 swaps after the section of the IRS code that regulates them. A salesperson may tell you a 1035 swap is a great deal because it allows you to get the features of a new annuity without incurring any taxes. But the exchange earns a big sales commission for the insurance agent which can influence the product the agent is promoting.

With a new annuity, you will start a new surrender period all over again. You can learn more about annuities and how to protect yourself at the Securities and Exchange Commission Web site.


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