What is an Annuity?
An annuity is a type of policy issued by an insurance company designed to accept and grow funds, and upon annuitization, create a stream of income or payments. The money you pay in can be either a lump sum or a number of payments. These contributions generally earn a rate of return, generally tax-deferred.
Types of Annuities?
There are two main ways to categorize annuities: immediate and deferred annuities and fixed and variable annuities. The immediate and deferred category has to do with when your income payout begins. The fixed and variable category has to do with how your contributions are invested.
What is Immediate Annuity ?
With an Immediate Annuity, your money provides guaranteed payments to you that begin soon after you make your initial payment. Depending on the tax-qualified or non-tax-qualified status of your annuity, a portion or the entire payment can be included in your taxable income. The owner can elect to receive guaranteed payments for life, or elect payments to be made over a specified length of time (period certain).What is Deferred Annuity?
With a deferred annuity, your income payments are usually put off for a period of time allowing the money you've contributed to earn interest generally tax-deferred. You choose when you want to start receiving income payments typically, upon retirement.
If you have an annuity, you're guaranteed at least a certain amount of money every year until the annuity expires or you become deceased. This amount is a payment plus interest, which can accrue at different rates.
What is Fixed Annuity?
With a Fixed Annuity, the insurance company places money in high quality fixed-rate investments such as bonds, where the insurance company will earn a fixed interest rate for a certain period of time. For most fixed annuities, the insurance company guarantees a minimum interest rate that you will earn, often for a specified period of time. With a Fixed Annuity, the insurance company is taking the investment risk.What is Variable Annuity?
With a Variable Annuity, money is placed in market-based investments. This may include stocks, bonds, mutual funds, or money markets. You may have the option to move the money around among the different investments. In addition, the rate of return can vary based on the performance of the investments. With a Variable Annuity, the risk is taken by the annuitant, rather than by the insurance company.
You can also choose between different types of annuities:
Fixed-period annuities, which only pay out for a certain number of years, usually between 10, 15, and 20. These are also called period-certain annuities. If you die before the end period, the remaining payments will go to a beneficiary you designate when you purchase the annuity.Lifetime annuities, which keep paying you for the rest of your life, are a great choice if you're young and/or plan to live forever.
You can buy an annuity by spending a lump sum up front, then after a certain amount of time you'll receive a percentage of that money back each year, plus interest.
Annuities are a steady stream of income, but they often have lower returns than other investment tools. It's possible to beat the guarantee, but not every annuity performs the same way. Still, annuities are useful as an investment tool if there's a market downturn but you continue to receive the same interest rate.
What are the Tax Advantages of deferred annuities?
Deferred annuities can also be a good way to help increase your retirement savings. The tax-deferral and compounding of interest provided by an annuity can help it to grow larger than an equal amount placed in a taxable account. Gains will be taxed as ordinary income once the money is withdrawn.
What is Death Benefits?
The death benefit is the value of the policy on the date of the annuitant's death. Some variable products have death benefit guarantees that provide protection if death occurs during a market downturn. The amount of the death benefit is called coverage, and the amount of coverage you need depends on your financial situation and the amount your beneficiaries need to survive without you.How the death benefit gets disbursed is usually up to the beneficiaries. Most people choose a lump sum disbursement \u2014 they get the entire amount at once, tax-free, divided between the number of beneficiaries.
Another option is to receive the death benefit as an annuity. An annuity works like an income in that the death benefit is divided up over a number of years into equivalent amounts that the beneficiary receives each year.
For example, the death benefit could be the greater of the amount paid in or the account value. If you die before payouts begin, your beneficiary will receive the current value of the annuity. Once you've begun receiving payments, the amounts paid to the beneficiary will depend on the payout option you originally selected.
What is Surrender Charges?
A surrender charge is a fee owed upon a premature withdrawal or "surrender" from an annuity. Surrender charges decline to zero over time and are a percentage of the accumulation value withdrawn. Not every annuity has surrender charges.
Popular Question regarding annuities?
Why are Annuities always bundle with Life Insurance is?
Annuities are often mentioned in the same conversation as life insurance because most annuity contracts are written by life insurance companies. However, life insurance is intended to meet the needs of the beneficiaries after the death of the policyholder. With annuities, the intention is to provide additional income to policyholders during their retirement years.
Do Annuities waive the surrender charges?
Annuities are designed to stay in-force over a period of time but sometimes the unforeseen happens. Many annuities will waive surrender charges upon death, terminal illness, or nursing home confinement.
After I own an annuity, I Can't transfer it to another company without paying taxes?
Federal tax rules allow you to transfer an annuity without being taxed. If the transfer qualifies as a rollover or 1035 exchange, it will be tax-free.
Deferred Annuities are only for older people?
Not necessarily. Deferred annuities may also make sense for other people who are looking for an additional way to save money for retirement, even when it is a few years down the road.
The risks of annuities?
Aside from the obvious value of receiving a large amount of cash as a lump sum, there are some risks with choosing an annuity to receive the death benefit. If the death benefit is worth $1 million, and you elect to receive an annuity that pays out 6% per year, you have to wait almost 17 years just to break even with what you'd get from a lump sum. That means that, if you're an older person, you may end up collecting less cash over time if you die before the entire amount is paid out. In other words, the annuity company wins its bet that you won't outlive your money.
Why people choose the lump sum death benefit?
Annuity owners work with insurance companies to create custom contracts specifying whether money will be leftover and, if so, who will inherit it. These contracts commonly include death benefit provisions, which allow the owner to designate a beneficiary to receive the greater of either all the money left in the account or a guaranteed minimum. After an annuitant dies, insurance companies distribute any remaining payments to beneficiaries in a lump sum or stream of payments.
Coverage amounts for an individual annuity policy usually range between $500,000 and $1 million. When calculating the amount of coverage you need, you should take into account all the expenses you help your loved ones pay for, such as a mortgage, college tuition, or medical care. Your coverage should be enough to continue paying for all those things, and more, when you're gone.
That's why it makes sense for the beneficiary to claim the death benefit as soon as possible as a lump sum.
PLUS the lump sum death benefit is tax-free.
It's important to include a beneficiary in the annuity contract terms so that the accumulated assets are not surrendered to a financial institution if the owner dies in annuity coverage.