Annuities

An annuity is a unique type of retirement account provided by an insurance company which gives certain guarantees and tax benefits. You can deposit money into an annuity over time or as a lump sum, and the insurance company agrees to make guaranteed periodic payments to you either immediately or at some point in the future. The insurance company also agrees to pay your designated beneficiary a death benefit if you die before collecting the full benefits to which you are entitled, typically equal to at least the amount of your deposits, minus any withdrawals taken.

You cannot take a tax deduction for the amount you deposit into an annuity (unless you place it in a tax-favored retirement account such as an IRA), but all earnings grow tax-deferred. Withdrawals of earnings are taxed as ordinary income if taken after age 59-1/2. If you take withdrawals before then, you will be subject to an additional 10% penalty tax, as with other retirement accounts. Also keep in mind that if you take more than a 10% withdrawal within the first few years of starting an annuity, the insurance company may impose surrender charges.

The IRS does not limit the amount you can contribute to annuities, so they are popular among investors who want to save more on a tax-deferred basis than their other retirement accounts allow. However, most insurance companies do place a fairly high limit on the amount you can deposit without prior authorization, typically at least $1,000,000.

Perhaps the biggest appeal of annuities is the opportunity to receive guaranteed retirement income for life. There are many varieties of annuities, but they can be boiled down to three basic types: fixed, indexed, and variable.

Fixed annuities provide a certain guaranteed interest rate for a specified period of time, like a CD. The longer the period for which you lock your rate, the higher your rate will be. Beware of locking it in for too long, though, because you might wish you hadn’t if interest rates were to rise. Fixed annuities also provide a fixed amount of guaranteed income at retirement for whatever period you specify. You could request income for as short as 5 years or as long as the rest of your life and your spouse’s life. The longer the payout period you choose, the lower your monthly income from the annuity will be. Choose wisely, because once you start receiving income, you can’t change your mind!

Indexed annuities allow your account balance to participate in price movements in an index, such as the S&P 500. They typically guarantee that your account balance will never drop below a certain balance, even if the index doesn’t perform well. However, they also impose caps on the amount you can earn each year, which might be much lower than the actual index performance in any given year. The performance of your account depends solely on price changes of the index between certain pre-determined dates, not including any dividends paid by the stocks that make up the index.

Variable annuities* provide a wide range of investment options which are typically like mutual funds. You choose how conservative or aggressive you would like to be. There are many types of variable annuities, but most include a provision that provides a certain guaranteed amount of retirement income for the rest of your life. If your investments perform better than the insurer’s guaranteed benefit, then your retirement income will increase. If your investments perform poorly, you will still receive the insurance company’s guaranteed benefit for life.

Annuities are sometimes criticized because they can be complex and inflexible, and the fees tend to be higher than for regular mutual funds that don’t have the guarantees or the tax benefits. Annuities are not for everyone, but they can be a good solution for the right situation.

Also remember that not all annuities are created equal. There is a wide range of benefits and fee levels among different companies, so it’s important to consult with an advisor you trust to make the best recommendation for you. If you’re considering one, take the time to understand how it works and know the fees involved so you can be sure it fits your needs.

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*Variable annuities are long term investment vehicles designed to help investors save for retirement and involve certain contract limitations, fees, expenses and risks, including possible loss of the principal amount invested. The investment return and principal value may fluctuate so that the investment, when redeemed, may be worth more or less than original cost. As with many investments, there are fees, expenses and risks associated with these contracts. All guarantees including the death benefit payments are dependent upon the claims paying ability of the issuing company and do not apply to the investment performance of the underlying funds in the variable annuity. Assets in the underlying funds are subject to market risks and may fluctuate in value.

Withdrawals of taxable amounts will be subject to ordinary income tax and possible mandatory federal income tax withholding. If taken prior to age 59 1/2, a 10% IRA penalty may also apply. Withdrawals affect the variable annuity’s death benefit, cash surrender value and any living benefit and may also be subject to a contingent deferred sales charge.

Variable annuities and their underlying variable investment options are sold by prospectus only. Investors should consider the investment objectives, risks, charges and expenses carefully before investing. This and other information are contained in the prospectus or summary prospectus, if available, which may be obtained from your investment professional. Please read it before you invest or send money.

Retirement Fundamentals
Insurance Fundamentals