What is an annuity?
In its most general sense, an annuity is an agreement for one person or organization to pay another a stream or series of payments. Usually the term “annuity” relates to a contract between you and a life insurance company, but a charity or a trust can take the place of the insurance company.
There are many categories of annuities. They can be classified by:
- Nature of the underlying investment – fixed or variable
- Primary purpose – accumulation or pay-out (deferred or immediate)
- Nature of pay-out commitment – fixed period, fixed amount, or lifetime
- Tax status – qualified or nonqualified
- Premium payment arrangement – single premium or flexible premium
An annuity can be classified in several of these categories at once.
In general, annuities have the following attractive features:
- Tax deferral on investment earnings
Many investments are taxed year by year, but the investment earnings—capital gains and investment income—in annuities aren’t taxable until you withdraw money. This tax deferral is also true of 401(k)s and IRAs; however, unlike these products, there are no limits on the amount you can put into an annuity. Moreover, the minimum withdrawal requirements for annuities are much more liberal than they are for 401(k)s and IRAs.
- Protection from creditors
If you own an immediate annuity (that is, you are receiving money from an insurance company), generally the most that creditors can access is the payments as they’re made, since the money you gave the insurance company now belongs to the company. Some state statutes and court decisions also protect some or all of the payments from those annuities. And your money in tax-favored retirement plans, such as IRAs and 401(k)s, are generally protected, whether invested in an annuity or not.
- An array of investment options
Many annuity companies offer a variety of investment options. You can invest in a fixed annuity which would credit a specified interest rate.
- Tax-free transfers among investment options
With annuities there are no tax consequences if you change how your funds are invested within the annuity. This can be particularly valuable if you are using a strategy called “rebalancing,” which is recommended by many financial advisors. Under rebalancing, you shift your investments periodically to return them to the proportions that you determine represent the risk/return combination most appropriate for your situation.
- Benefits to your heirs
There is a common misconception about annuities that goes like this: if you start an immediate lifetime annuity and die soon after that, the insurance company keeps all of your investment in the annuity. That can happen, but it doesn’t have to. To prevent it, buy a “guaranteed period” with the immediate annuity. A guaranteed period commits the insurance company to continue payments after you die to one or more beneficiaries you designate; the payments continue to the end of the stated guaranteed period—usually 10 or 20 years (measured from when you started receiving the annuity payments). Moreover, annuity benefits that pass to beneficiaries don’t go through probate and aren’t governed by your will.
Why should I consider purchasing an annuity?
Annuities can serve many useful purposes.
If you are in a saving-money stage of life, a deferred annuity can:
- Help you meet your retirement income goals. Employer-sponsored plans such as a 401(k), 403(b) or Keogh are an important part of planning for retirement. However, contributions to these plans and to IRAs are limited, and they might not add up to enough for the retirement income you need, especially if you started saving for retirement late or had contributions interrupted—perhaps due to job changes and/or family responsibilities. Moreover, your social security and defined-benefit pension (if you have one) may provide less than you need to retire. Remember that the purchasing power of defined-benefit pension income is eroded by inflation.
- Help you diversify your investment portfolio. Investment experts routinely advise that, to get the best return for a given level of risk, you should diversify your investments among a number of asset classes. Fixed annuities, in particular, offer a unique asset class—an investment that is guaranteed not to decrease and that will actually increase at a specified interest rate (and, often, potentially more). The guarantees are supported by the claims-paying ability of the insurer.
- Help you manage your investment portfolio. Investment experts routinely advise that, whenever your investments in various asset classes get too far from the percentage allocations you prefer, you “rebalance” to the original formulation, by shifting funds from the classes that have grown faster to the ones that have grown more slowly. If you do it in a fixed annuity, you don’t pay capital gains taxes. When you eventually withdraw money from the annuity (which could be many years after the rebalancing), you pay tax then at the ordinary income rate.
If you are in a need-income stage of life, an immediate annuity can:
- Help protect you against outliving your assets. Social security pays retirement income for as long as you live, as do defined-benefit pension plans. But the only other source of income available that continues indefinitely is an immediate annuity.
- Help protect your assets from creditors. Generally the most that creditors can access is the payments from an immediate annuity as they’re made, since the money you gave the insurance company now belongs to the company. Some state statutes and court decisions also protect some or all of the payments from those annuities.
Fixed annuities may not be suitable for all. You should consult a licensed insurance agent regarding your financial objectives and unique situation to help determine if a fixed annuity is right for you. Please make sure you review all marketing materials, specimen contracts, buyer's guides, and forms related to the annuity to ensure that it meets your short-term and long-term financial situation and liquidity needs.
Withdrawals may be subject to income tax, and a 10% federal income tax penalty may apply to withdrawals before age 59 1/2. Additionally, certain charges (referred to a surrender charges) may apply if you withdraw more than the penalty-free amount in a year. Under current law, tax deferral is a basic feature of tax-qualified plans. Placing qualified funds into an annuity does not provide any additional tax benefit.
Fixed annuities guarantee a minimum interest rate on all or a precentage of each contribution over the life of your contract less any withdrawal and/or deductions and early surrender charges.
The stated fixed interest rate in this advertisement includes any bonuses received and is good for the first year.
- Unlike CD's, fixed annuities and indexed annities are not insured by FDIC.
- Some fixed annuiteis come with high guranteed interest rates that can decrease after a set number if years to a much lower minimum interest rate determined by law.
- Investor can lose principal if an indexed annuity is terminated prior to the end of the surrender period.
- Some indexed annuities gurantee a minimum interest rate of 0%.
- Indexed annuities may not be suitable for all investors. Features such as participation rates, rate caps, and spread/asset/margin fees may change over time and adversely affect your return if an insurance company subsequently lowers the participation rate or cap or increase the spead/asset/margin fees.
- The principal guarantee and income for life guarantee features of fixed and indexed annuities are subject to the claims-paying ability of the issuing insurance company.
- If you take an early distribution from an annuity you may be subject to surrender charge which could result in a loss of prinicipal. You may also be subject to a tax penalty if you make a withdrawal before age 59 1/2.
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Ad Mor Insurance, LLc
1161 Pond Cypress Drive
Virginia Beach, VA 23455