Annuities

Annuity rates can often change in tandem with the rates paid on other fixed interest investments. However, whenever rates drop, the real return on annuities could potentially be higher than other interest-paying assets.

First of all, fixed deferred annuities typically promise a minimum rate of return for the term of the contract. For example, if you select a fixed annuitythat locks in current rates for five years, you will earn a competitive rate for the first five contract years.  After that, you will receive no less than the minimum rate, regardless of how low market rates might possibly go.  Such an annuity is called a multi-year guarantee annuity.

Second, annuities are tax-deferred investments. That means the earnings on your annuity’s principal will compound without you owing current taxes. Other fixed income investments, such as CDs, are taxed as interest is credited (of course, CDs are FDIC insured for up to $250,000 per account per beneficiary through 12/31/09). Even if you reinvest the interest, you have to pay income tax. This reduces the effective rate of return on your taxable fixed interest investments.

Please note, however, that annuities are designed for long-term investing and ordinary federal income taxes and a 10% tax penalty could apply to withdrawals taken prior to age 59 ½. 

Third, many annuities pay bonuses for the first year. This extra annuity rate could boost the yield over the term of the contract. However, early withdrawals from annuities could result in surrender charges that reduce the benefits of these bonuses. Please note that annuities that pay bonuses may have higher fees and charges and longer surrender periods than other annuities that do not offer a bonus.   
 
In some cases, you can also put off taking money out of an annuity and therefore delay paying income taxes. This could allow you to arrange your payments to coincide with time periods when you are in a lower tax bracket.  For example, if you retire at age 60 and don’t start social security until age 65, you may have a few years in the 15% tax bracket and this is the best time to make withdrawals from your annuity. 

Additionally, you can sometimes postpone receiving payments from annuities for your lifetime and structure a plan to create additional funds for your heirs. In this case, your heirs will pay income taxes at their respective tax rates. You can’t do that with CDs (of course, annuities and CDs are both subject to estate taxes if the owner’s taxable estate exceeds $2 million).  If using an annuity is for inheritance, please consult a retirement advisoras it would be better to replace the annuity with life insurance.
 
As previously mentioned, annuity benefits and guarantees are based upon the claims-paying ability and financial strength of the underlying insurance company and are not government insured. Additionally, one should remember that annuity surrender charges are often based upon the time the insured has been invested in the annuity and surrender schedules vary from company to company.  If you are interested in some information on fixed deferred annuities with competitive base rates, bonus rates, and guaranteed yields to maturity, then please order the booklet from this blog “Annuity Owner Mistakes.”  Also use the fixed annuity calculator.

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There’s more to retirement than managing assets; you must also ensure that those assets are titled correctly. Not doing so, particularly in regard to annuities, can have major implications for you and your loved ones.

Let’s say you decide to invest move some of your assets from a mutual fund to an annuity because you want your beneficiaries—your children—to receive the annuity death benefit. The chart below illustrates.

Sample titling of an Annuity vs. Mutual fund:

This seems simple enough but not so fast. Mis-titling the annuity could potentially result in an unexpected payout with undesirable tax consequences. Here’s how. Again, John and Jane Doe are the owners of the annuity. If John Doe dies, the annuity would in all likelihood pay out to the beneficiaries, the children, even though Jane Doe is alive. That’s because death of an owner generally triggers a payout to the beneficiaries.

If you’re in a second marriage, you may face a conundrum: You want to share ownership of property with your new spouse, but you also want your children from your first marriage to inherit your share of the property when you die. What to do? You and your spouse could be joint owners of the account, with the beneficiaries listed as your children. As beneficiaries, then, your children would receive the annuity benefit upon your death.

Although the husband and wife have been listed as joint owners, you don’t want to list them as joint annuitants or else the children will receive nothing until the death of the second annuitant.  The issue of titling your assets, an estate planningissue, is not just for the rich but for anyone that owns anything of value.

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Retirees often want to know how quickly they can get to their money in case they need to cover extraordinary expenses such as a medical emergency, or a home or auto repair. This need for liquidity may cause them to avoid deferred annuities. However, when you look closely, you’ll see that annuities can possibly provide access to funds that can accommodate many circumstances.

For instance, what if you need to take out money before the deferred annuity matures?  Most companies will let you remove a portion of your account’s value each year without paying a withdrawal charge. This is usually 10%, and once the surrender charge period expires, you’ll be able to withdraw as much as you want without paying any penalties to the issuer. But annuities also can allow for other circumstances.

Suppose you are worried about money for future long-term care or a medical emergency? Some annuity companies will give you penalty-free access to your funds if you have to go to a nursing home or come down with a critical illness. 

And what about income from your deferred annuity?  If you reinvest, the income is not reported on your tax retyrn and in fact, may help lower the tax you pay on your social security income.  This is a welcome senior tax break.

If your situation changes and you need income from a deferred annuity, you will have the opportunity to annuitize the contract and receive payments for a fixed period. You can also get payments that will last your lifetime or even as long as you and your spouse live. Once you annuitize the contract, the annuity is not counted for Medicaid qualification purposes (the income could be, however).

What happens when you die? Will your survivor get the money he or she might need?

The annuity company will transfer the account’s value to your designated beneficiary without any surrender charges, penalties, or probate fees.

Do you think that there is a chance that creditors might come after your money? Many states’ laws protect annuities from creditors.

So before you decide that deferred annuities don’t offer the ease of access that you might need to your funds, look at the complete picture. Examine what you might need this money for—what situations would you consider potential emergencies? It’s possible that an annuity company has just the right option for you.

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The word “annuity” brings to mind different meanings for many investors.  That’s because there are different types of annuities designed for different purposes.  One of these is the immediate fixed annuity, which can provide an immediate stream of cash payments over a lifetime or a defined period of time.

If the investor has chosen a lifetime payout retirement option, he or she typically pays a single premium to an annuity company. In return, the company agrees to pay the investor regular and ongoing cash payments for life, or for a lesser amount to continue over the life of both spouses. Although many investors choose to receive monthly payments, it is also possible to receive quarterly, semi-annual, or annual payments as well.
Assuming the payments are structured over a lifetime, the investor is provided with a lifetime income he or she cannot outlive. Such an investment is useful for investors requiring additional retirement income, for support of a community spouse in the event the other spouse is in need of nursing-home care and is seeking to qualify for Medicaid (immediate annuities can be treated as exempt asset in some states), for making lifetime payments to cover long term care needs, or for paying long term care insurance premiums.

A portion of each payment is considered a return of premium and therefore not taxable to the investor. The remainder is considered interest and will be subject to federal and state income taxes.  For example, for a male investor age 70, 68% of each payment is nontaxable to age 86 (then all amounts thereafter are taxable).

One drawback to these products is an early death. In such a case, the annuity company keeps the funds and the income ends. This early-death financial risk is sometimes perceived as a negative feature among some investors. However, there is a possible solution to this concern as some annuity companies will guarantee a return of the investment to heirs in the case of an early death.  The feature is referred to as a “refund” provision.  Other companies offer “commutation” which allows the investor to change his mind and recover his initial investment (usually with a surrender charge), for example, in the case of a terminal illness.  These features make the immediate annuity more flexible and remove the chance of having one’s investment disappear in the case of untimely death.

Please note, that annuities are long-term investments that are designed for retirement purposes. Annuities are also subject to administrative fees, mortality charges, and surrender charges that can apply to early withdrawals, and these fees tend to vary from company to company. Annuity premium payments and any other guarantees are subject to the claims-paying ability of the issuing company. For this reason, it is very important to consider the financial standing of the issuing company before you purchase an annuity.

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Fixed annuities can be popular among seniors. They are easy to buy, you know exactly how long you must tie up your money, and the IRS will let you defer the income tax on the earnings. 

But one point that may have stopped you from investing in an annuity is that some traditional fixed annuities do not lock in the interest rate for the duration of the contract. This means that after the initial period, which is typically one year, the return that the annuity company pays could possibly go higher or lower each year thereafter. However, there is a type of annuity that fixes the return for the entire contract’s term. This way you will know exactly how much you’ll earn while you own the contract–see the fixed annuity calculator for a projection.  

CD-annuities (also known as multi-year guarantee annuities) provide level interest rates for the entire term so you won’t get any surprise notices during this time. You select the term, which generally ranges from three to ten years when you make the investment. At the end of the term, you will usually have a 30-day window to withdraw all or part of your money, or renew the contract for another multi-year period. The withdraw charges expire when the term ends.

As with traditional annuities, there are no income taxes on the earning while they remain in the account. Therefore, you won’t get a 1099 form to file with the IRS each year. Nor will you have to worry about income taxes if you renew the contract at the end of the term, and you get to name a beneficiary. This means that if you die while you own the CD-annuity, your heirs will quickly receive the account’s value without going through probate. Then they’ll  have the option to take a lump sum payment, or a systematic payout.

Note that if you also get an annuity with a market value adjustment (MVA), and interest rates do decline, you can cash out your annuity prior to term and be rewarded for the MVA adjustment.  Of course, always buy annuities with the intention of holding to term.

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Many seniors purchase fixed annuities for potential safety, tax savings, and asset protection. In some cases, insurance companies will offer a higher interest rate for a limited time period to encourage those investments. But what happens after that time period ends? Other than the minimum rate guarantee, do you have any assurance that you will still get a good return? 

Pass-through annuities could possibly reduce that concern by limiting the amount of money the company makes on your investment.

To achieve a basic understanding about how this works, let’s look at a hypothetical example (please note that this example is for illustration purposes only and is not based upon the performance of any particular annuity product).  Say you bought a fixed annuity that had the traditional method of crediting interest. If the first year’s rate included a 5% bonus, plus the 3% minimum, you could be looking at 8%. And you might think that’s pretty good. 

Then year two rolls around and it’s time for rate renewal. The annuity company might only be contractually required to the minimum interest rate, even if they earned more than that on your premium payments. 

With a pass-through annuity you can potentially achieve a better result, since there is a contractual guarantee in place that limits how much of the earnings an insurance company can keep. Once an insurance company takes its share, the rest of the investment return is “passed through” to you. 

Of course, any additional fees that are charged for this guarantee could reduce your overall return. The interest rate and pass-through features of these annuities can also vary from company-to-company. Annuities are designed for long-term investing. Ordinary federal income taxes and a 10% tax penalty could apply to withdrawals taken prior to age 59½. Annuity benefits and guarantees are based upon the claims-paying ability and financial strength of the underlying insurance company, and are not government-insured. Surrender charges can also apply to withdrawals, based upon the time the insured has been invested in the annuity. 

Because there are so many annuities on the market, get retirement help by locating an experienced annuity agent.

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When the markets are volatile and the interest rates low, investors turn to relative safer investment options such as an index annuity. Let us quickly try to understand the term and what are the advantages and disadvantages of investing in this kind of an investment vehicle. An Index annuity is an investment vehicle which is closely linked to some leading index such as the S&P 500. If the stocks rise then investors benefit from the rise in stock prices. If the stock markets fall, investors are safeguarded against the falling stocks which assure a minimum return of 3%.

This is the biggest advantage of an index annuity. While on one hand an investor gains from rising stocks a falling market does not erode the base capital and still ensures a small return. Financial institutions which have annuity products make their money from the spreads. In a rising market they make more profits than what is passed down to the investor. The profits so accrued during a bull market are used to compensate investors during a bear phase.

The index annuity is a relatively newer product in the annuity space. Earlier annuity products only varied around variable equities and fixed annuities which invested the funds in secure investment vehicles.  Index annuities are good investment vehicles for investors who have a long term investment horizon. Of all the products that are offered by annuity companies the investments have a lengthy time frame (5 years or more).  So if an investor is ready to invest for a long term then index annuities can be a good bet.  There are features such as the “annual reset” rate which is used to lock-in the rate of interest.  In other words the financial institution which is issuing the annuity product has a cap on the interest rates in times of bull phases.

The index annuity is an investment vehicle which is good for investor who have moderate to high risk appetite.  There may be instances when an equity market may go for a prolonged “bear” phase. In these kind of scenarios the returns that are generated from the equity will be consistently low over a period of time.  Investors who have sudden requirement of funds may want to withdraw the investments that have been already made into an index annuity fund. The investor may have to pay charges for early withdrawal. Before buying an index annuity an investor should be aware of all the features of the product before taking the plunge.

Companies selling index annuities will offer features which may not be significantly different. However, when buying a product an investor should look for features which suit their individual requirements.  Representatives may try to hard-sell a product but as investors we need to take informed decisions.  An index annuity product may be a good fit for a young investor who wants to invest in for securing financial needs after retirement.  Of other annuity products available in the market,  an index annuity can give good returns in the long-term. So, do your study before you make the choice. Get help from an experienced retirement advisor who can help you compare several offerings.

But the current timing makes the index annuity a particularly opportune retirement option because if the market jumps from these low levels, you share in the gain yet you have protection of your principal if the market slumps.  Select a very solid insurance company, rated AA or AAA by Standard and Poors.

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Stability and safety are important to many seniors, and these are only two of the reasons why immediate annuities are popular investments. A check arrives every month and part of the income is considered a tax-free return of your principal. As long as the annuity company is financially sound, the payments will continue for the life of the contract (annuities are guaranteed by the claims-paying ability of the issuing company).

However, consumers sometimes believe that immediate annuities are illiquid, irreversible investments, and cannot provide for future lifestyle changes. Nonetheless, there are some immediate annuities with options that may add flexibility to your financial plan.

Immediate annuities can possibly include an option that would allow you to receive extra cash at specific anniversary dates. For example, this might be at the 5th, 10th, or 15th anniversary of your investment. Exercising this option will reduce your future payments (the distribution may be fully taxable, so consult with your tax professional).

Suppose you needed money to cover an emergency, like paying for caregivers or a home repair. Some annuity companies will let you take up to six payments at once. You would not, however, receive checks for the following six months (payments may be fully taxable so consult with your tax professional).

You may also have the ability to provide a cash benefit from your immediate annuity to your heirs. This would be a pre-determined percentage, such as 25% or 50% of the amount of your initial investment. Selecting this option will reduce your monthly annuity checks, and may have tax consequences.

Annuities are so varied and there are so many different options provided, it’s essential to speak with a retirement advisorto see a range of products and solutions available.

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An annuity is an investment which an individual makes to ensure a lifetime income. There are different types of annuities. These are Indexed annuity, variable annuity, fixed annuity, immediate annuity, deferred annuity and retirement annuity.

Equity Indexed annuities grow depending upon the performance of an underlying stock market index. It is a good source of investment if the stock market is in an upward cycle. In an indexed annuity the principal is guaranteed and the profits are locked in. As a result investors do not lose their money. The annualized rate of return for these kinds of products can be anything between 5% to 9%.  The best time to invest is when the stock market is depressed.

A variable annuity allows an investor to grow investments in portfolios. This is one of the most preferred methods of annuity investments because the money is invested in conservative stocks and the payments are tax deferred. Investors can choose the method of payouts. The expected rate of return for variable annuity is 8% to 10% assuming equity accounts are selected.

Fixed income annuities come with a time frame of 5 to 15 years. This type of annuity is more suited for conservative investors to ensure that their principal is guaranteed. The insurance companies which manage the fixed annuities place the funds in government securities or in bonds of stable companies. At present rates one can expect a return of 4.5% on an investment of $100, 000 but check rates with your retirement advisor as many companies pay more.

Another form of annuities that is gaining popularity is immediate annuities because of the aging population. As the name suggests an investor in these annuities start gaining on their investments as soon as it is made. The rate of return on immediate annuities depends on many factors such as age, gender, investment amount, and type of payout.

The next type of investment in annuity is deferred annuity. In this arrangement, the investor benefits from tax benefits on the investments made.  The withdrawals from a deferred annuity are made after retirement to enjoy the golden years of one’s life.  The returns from deferred income are taxable. A fixed deferred annuity will give a steady rate of return. Investors can choose the mode of investment in the arrangement-either as a lump sum or payments made over time. The rate of return of a deferred income arrangement will depend on the investment corpus, starting age of the investment and whether the payout is in a variable or fixed mode.

The most common and oldest rate of annuity is retirement annuity. People invest in these types of investment vehicles to ensure that they get a steady return after their retirement.  Retirement annuities are offered as an option at retirement, as settlement of a pension payout.  In this type of instrument, investors can choose between a fixed return and a variable return. 

Investors have been investing in annuities to safeguard their future incomes. The annuity rate of return can be lesser than other investments such as equities or foreign exchange. However they will always remain as one of the the favorite retirement options of retirees to ensure long-term returns and stability.

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Anybody looking to invest in an annuity, be it an index linked annuity or otherwise, would be well advised to shop around before choosing which annuity company to place his or her investment with.

The market is a thriving and busy area, and there are many hundreds of annuity companies to choose from, so how does one go about such an arduous and ultimately important task?

How to choose

Firstly, it is important that you know which type of annuity you require, what you expect to gain from the investment, and when.

In many cases, those with private pensions will be contacted by their pension supplier once their pension kicks into action, or matures. It is always a worthy consideration to take out an annuity at this point – especially if one has retired earlier than the set age – as investing some of that pension can provide an ongoing extra income in later years.

However, it is also important not to simply tick the ‘yes’ box on your pension providers’ mail, as they may not be the best available annuity for you.

A quick search on an Internet search engine will produce a list of many providers of annuities, and you should peruse these to look for deals that suit you.

Do you want a guarantee, or to take a potentially higher paying option that carries more risk?

Some annuity companies will offer you an agreement that promises a guaranteed payment at a certain percentage, yet you could –potentially – earn more elsewhere, with different types of guarantee. Look for an indication of the ‘floor’ level – this is the lowest repayment that you can take from any annuity, and it is effectively the guarantee of the minimum return you will get from your investment.

Who to ask?

There are many advisors on the subject of annuity policies to be found, and again a search through a web engine should provide you with a good choice.

Perhaps better is to ask around friends and family, those who may recently have entered into an annuity arrangement, and speak to the advisor who helped them on their way to a successful deal.

Major brands

Look, also, for names that you know, as these will most likely be organizations that have been trading in the annuity marketplace for along time.

Look for well-known insurance companies and banks that have insurance divisions, and make sure you investigate every possible option before making any kind of commitment to one single supplier.  Make sure the annuity company is rated AA or better by Standard and Poors if you want to have an annuity company that can weather difficult economies.

The pitfalls

Done properly and with thorough investigation, securing an annuity policy should be a way to ensure an income for your later years.

There are, as with all such things, some downsides to look out for. Pay attention to small print about fees and surrender charges  – these can be levied if a policy is matured early – and to annual rate resets that mean the interest on the account starts again at the beginning of each year, and make sure – above all – that you fully understand every aspect of the agreement you are about to enter into.  Read the annuity contract.

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